The relation between fees and return predictability in the mutual fund industry

- Confirmation of a negative relation between funds' before fee performance and fees
- Fees are significant return predictors for funds with negative and positive relations with fees.
- In both cases fees are negatively associated with return predictability.
- Macroeconomic variables are useful in selecting funds with superior performance.

We propose and test a methodological framework to examine the relation between mutual fund fees and return predictability. Gil-Bazo and Ruiz-Verdu (2009) drew attention to the puzzling fact that funds with worse before-fee performance charge higher fees. We make another contribution to the literature about the market for equity mutual funds: we find strong evidence of predictability for mutual fund fees. Funds with both positive and negative relations with fees show strong evidence of negative return predictability for their fees. Our findings are robust to alternative estimation methods and under the assumption of conditionally heteroskedastic stock returns. Our results also show that conditioning information (e.g. dividend yield, t-bill yield, default spread and term spread) are useful in selecting funds with superior performance and are valuable for asset allocation decisions.