Evaluating Mutual Funds:
A Fund vs. Its Former Self - New York Times : The idea is to compare each fund's returns with how it would have performed had it simply held, without trading, the stocks it listed in its most recent public disclosure. The study was done by three finance professors: Marcin Kacperczyk of the University of British Columbia and Clemens Sialm and Lu Zheng of the University of Michigan. They focused on what they called the "return gap": the difference between a fund's actual returns and what it would have earned had it stuck with its most recently listed holdings. The S.E.C. requires that funds make such disclosures twice a year; the professors report that nearly half of all funds do so at least quarterly. The study found that, on average, funds with consistently positive return gaps were much better bets for future performance than those that were consistently negative, regardless of the frequency of portfolio disclosures. They analyzed more than 2,500 domestic equity mutual funds over a 20-year period - 1984 through 2003. http://papers.ssrn.com/sol3/papers.cfm?abstract-id=676103
The professors say they believe that their approach works well because it evaluates fund performance more precisely than the customary practice of comparing it with a market benchmark.... The professors' approach sidesteps these problems because it doesn't compare funds with generic benchmarks. Each fund is compared only with itself - or what its performance would have been had it not made changes in its portfolio....
Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch.