We investigate the conditional performance of a sample of German equity mutual funds over the period from 1994 to 2003 using both the beta-pricing approach and the stochastic discount factor (SDF) frame- work. On average, mutual funds cannot generate excess returns relative to their benchmark that are large enough to cover their total expenses. Compared to unconditional alphas, fund performance sharply deteri- orates when we measure conditional alphas. Given that stock returns are to some extent predictable based on publicly available information, conditional performance evaluation raises the benchmark for active fund managers because it gives them no credit for exploiting readily available information. Underperfor- mance is more pronounced in the SDF framework than in beta-pricing models. The fund performance measures derived from alternative model specifications differ depending on the number of primitive assets taken to calibrate the SDF as well as the number of instrument variables used to scale assets and/or factors.
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