Smaller Riskier, Mutual Funds Outperform Their Bigger Rivals

Buy a big, well-diversified stock mutual fund, your friend tells you, you can do no wrong.

That advice is OK but not by any means the whole story. Big stock mutual funds deliver decent returns but if you want to increase them, you should look at smaller, riskier stock mutual funds, according to two professors at Georgetown University's School of Business.

William G. Droms and David A. Walker examined 151 mutual funds between 1971 and 1990. They categorized the riskiness of the funds by looking at the standard deviation of their mean returns, or how much their portfolios varied from their average return over time.

Funds with the lowest standard deviation, or funds with the most consistent peformance from year to year, returned about 10.6 percent a year. These funds had, on average, $3.86 billion in assets, a stock turnover rate of 55 percent and a mean expense ratio of 0.94 percent of assets.

Funds with the highest standard deviation earned about 14.2 percent a year. These funds had only about $2.1 billion in assets. But they bought and sold stocks in their portfolio more often, with a turnover rate of 81 percent, and their mean expense ratio was 1.19 percent.

The professors conclude that high risk funds have higher expense ratios, "perhaps because they do more research." Larger funds are more broadly diversified and so, are better able to manage risk.

Bottom line: smaller funds with higher risk may be worth investing in even though they have higher expense ratios, assuming your a long-term investor.

Smaller Riskier, Mutual Funds Outperform Their Bigger Rivals

Smaller funds with higher risk are a good choice for the long-term investor.

stocks, mutual funds, assets, investors, risk , market, brokers

Buy a big, well-diversified stock mutual fund, your friend tells you, you can do no wrong.

That advice is OK but not by any means the whole story. Big stock mutual funds deliver decent returns but if you want to increase them, you should look at smaller, riskier stock mutual funds, according to two professors at Georgetown University's School of Business.

William G. Droms and David A. Walker examined 151 mutual funds between 1971 and 1990. They categorized the riskiness of the funds by looking at the standard deviation of their mean returns, or how much their portfolios varied from their average return over time.

Funds with the lowest standard deviation, or funds with the most consistent peformance from year to year, returned about 10.6 percent a year. These funds had, on average, $3.86 billion in assets, a stock turnover rate of 55 percent and a mean expense ratio of 0.94 percent of assets.

Funds with the highest standard deviation earned about 14.2 percent a year. These funds had only about $2.1 billion in assets. But they bought and sold stocks in their portfolio more often, with a turnover rate of 81 percent, and their mean expense ratio was 1.19 percent.

The professors conclude that high risk funds have higher expense ratios, "perhaps because they do more research." Larger funds are more broadly diversified and so, are better able to manage risk.

Bottom line: smaller funds with higher risk may be worth investing in even though they have higher expense ratios, assuming your a long-term investor.

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