Funds of Funds (FOFs) are mutual funds that hold shares of other mutual funds. Over the past couple decades, they have grown in popularity. For example, in 1999 there were 212 such funds with total net assets of $48 billion. By 2010, the figures had grown to 932 funds and $673 billion in total net assets.
Hybrid-Funds of Funds
Hybrid-Funds of Funds (HFOFs) are the most popular type of FOF
, accounting for as much as 80 percent of funds of funds’ total net assets. The vast majority of HFOFs are actively managed, and they invest in a combination of stock, bond and money market mutual funds. Although each fund is different, hybrid-FOFs will normally hold between 3 and 20 mutual funds and invest 30 percent to 70 percent of their assets in equity funds, 30 percent to 60 percent in fixed-income funds and up to 30 percent in money market funds.
FOFs often have similarly elastic mandates, which give both FOFs and HFOFs more investment flexibility than traditional equity and bond mutual funds. This allows them to alter their asset allocations in response to changing market conditions. As a result, they provide a good sample to test market-timing skills.
The Timing Ability of Hybrid Funds of Funds
Javier Rodriguez, author of the paper The Timing Ability of Hybrid Funds of Funds
studied the performance of 58 HFOFs and 116 traditional hybrid mutual funds to see if they exhibited market-timing skill. The study covered the period from January 1999 through June 2010. Rodriguez used a multi-factor asset pricing model able to explain 97 percent or more of the variation in fund returns. The following is a summary of his findings.
Rodriguez found evidence of perverse market-timing skills in both FOFs and HFOFs. In the case of HFOFs, 75 percent of the sample exhibited negative timing skills, with about 25 percent of them being statistically significant at the 5 percent level. On the other hand, just 25 percent exhibited positive timing skills and just 5 percent of the total were statistically significant.
The results were similar for FOFs. The study found 64 percent of the sample showed negative market-timing coefficients, with about 11 percent being statistically significant at the 5 percent level.
While the statistical significance of Rodriguez’s results weren’t high, both the HFOF and FOF samples showed perverse timing ability. The evidence of perverse timing ability was stronger for HFOFs. The lesson for investors is: If even professionals fail to persistently add value through market-timing efforts, what are the odds that individual investors can do so?
The Bottom Line
A fitting conclusion are these words of caution from Warren Buffett: “Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”