Performance Evaluation and Market Timing: the Skill Index

MERTON (1981) examines the creation of value by fund managers selecting between stocks and fixed income instruments through market timing. HENRIKSON and MERTON (1981) proceed to propose empirical tests of funds and manager performance in market timing. BRITO, BONA and TACIRO (2003) generalize the results of MERTON (1981) and HENRIKSON and MERTON (1981) for actively managed funds with a clearly defined benchmark portfolio. In the generalized context of active portfolio management, this paper proposes a new index – the Skill Index of Brito (SIB) – to measure the performance and efficiency in market timing of actively managed funds. The paper proceeds to test the performance and skill of hedge funds in Brazil using the SIB. A representative sample of 32 hedge funds with a window of 90 trading days on October 31, 1999 was obtained. The empirical tests of performance and skill use the interbank borrowing and lending rate as the passive benchmark. The results indicate the significance at the 5% level of the SIB for ten hedge funds in the sample. Among them seven funds also have shown significance at the 1% level. In sum the results indicate a majority of hedge funds with no significant skill in the Brazilian market in the examined period.