Identifying the Value Premium: A Test of Mutual Fund Performance Measures

This paper extends recent discussion on the effectiveness of mutual fund performance measures. We utilize the well-known value premium to examine the ability of mutual fund performance measures to distinguish between the results of value funds and growth funds. Specifically, we examine the effectiveness of mutual fund performance measures over a sample period where value outperforms growth without question, where such measures ought to identify the superior performance of value funds. We find that the Capital Asset Pricing Model successfully identifies superior performance of value funds. The Fama-French three-factor model, on the other hand, provides an inaccurate comparison. We conclude that measurement using the Fama-French three-factor model is biased against value funds and should not be used to judge the performance of value funds, or in general, funds containing a significant proportion of value securities. We suggest that a similar bias would exist for mutual funds holding small-firm securities.