An Examination of UK Unit Trust Performance within
the Arbitrage Pricing Theory Framework
DR. JONATHAN FLETCHER
Department of Finance and Accounting, Glasgow Caledonian University, Cowcaddens Road, Glasgow G4
0BA, United Kingdom. Ph: (0141) 331-3796
Abstract. This paper examines the performance of a sample of 101 United Kingdom unit trusts within an
Arbitrage Pricing Theory framework and considers the relationship between performance and a number of trust
characteristics. For this sample of trusts there appears to be little relationship between performance and the
investment objective, size and expenses of the trusts. Also portfolio strategies using past trust performance to
rank the trusts fails to generate significant abnormal returns relative to two different benchmark portfolios.
Keywords: UK Unit Trusts, performance, Arbitrage Pricing
Modern portfolio performance evaluation stems from Jensen (1968, 1969) who developed
a performance measure within the theoretical framework of the Capital Asset Pricing
Model (CAPM). Connor and Korajcyzk (1986) extend the applicability of the Jensen
(1968) performance measure to an Arbitrage Pricing Theory (APT) framework building
on the competitive equilibrium version of the APT developed by Connor (1984). This is
applied by Connor and Korajcyzk (1991) to evaluate the performance of a sample of US
mutual funds against an APT benchmark portfolio.
Recent empirical research has renewed interest in the performance of managed funds.
Performance studies are closely related to tests of market efficiency. Fama (1991) consid-
ers these as tests of whether investors possess private information. The early studies of
Sharpe (1966) and Jensen (1968) found little evidence of superior ability by fund man-
agers. This has been confirmed by a recent study of Elton, Gruber, Das and Hlvaka (1993).
However the results of Ippolito (1989) and Grinblatt and Titman (1989a, 1994) suggests
that some fund managers may possess superior ability.
A lot of the controversy surrounding the inferences of fund performance relate to the
choice of the benchmark portfolio.
Ippolito (1989) and Elton, Gruber, Das and Hlvaka
(1993) find vastly different conclusions about performance for the same group of mutual
funds (see also Lehmann and Modest (1987) and Grinblatt and Titman (1994)). This stems
from the difficulties in identifying an appropriate benchmark portfolio.
Another related issue in performance studies are the relationships between performance
and various fund characteristics eg. size. Grinblatt and Titman (1994) found that US mutu-
al fund performance was positively related to turnover but not to size or the expenses of
the fund. Elton, Gruber, Das and Hlvaka (1993) found a negative relationship between
annual expense ratios and performance which was contrary to Ippolito (1989).
Review of Quantitative Finance and Accounting, 8 (1997): 91–107
© 1997 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.