Emerging Market Mutual Fund Performance and the
State of the Economy∗
Ayelen Banegas
November 2010

Abstract
Following the financial liberalization of many Asian, European, and Latin American countries emerging markets have become a central player in the global economy. As a result the universe of equity funds investing in these developing economies has been in continuous expansion. In this paper we propose a set of asset class specific predictive variables for emerging markets and exploit them in order to identify those funds that outperform the market in different phases of the economic cycle. We employ a comprehensive survivorship-bias free universe of global and regional emerging market funds and use a Bayesian framework that incorporates predictability in manager skills (stock selection and benchmark timing skills), fund risk loadings and benchmark returns by exploiting ex-ante business cycle related state variables. Our results provide empirical evidence of return predictability and the economic value of active management in emerging markets.

∗

I would like to thank Allan Timmermann for his guidance and support. I am also grateful to James
Hamilton, Bruce N. Lehmann, Ross Valkanov and Debbie Watkins for their helpful comments. I also benefited from discussions with Ben Gillen. Finally, I want to thank Russ Wermers for providing me with the mutual fund dataset.

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Introduction

During the last decades the mutual fund industry has been continuously growing and gaining importance in global financial markets. As of end of 2007, total worldwide mutual funds’ assets amounted to 26.2 trillion dollar, with the US accounting for 46% of the market. As the industry evolved, mutual funds have been gaining the interest of academics and practitioners for whom central questions have been related to performance measurement and the study of