Correspondence: Olaf Stotz, Frankfurt School of Finance & Management, Sonnemannstrae 9-11, D-60314 Frankfurt, Germany

¹holds the BHF-BANK Endowed Chair of Private Wealth Management at Frankfurt School of Finance & Management, Germany. His research interests include wealth management, empirical finance, asset pricing and behavioural finance. His research has been published by various international academic journals, has been discussed in the financial press and is also applied in the financial industry. Before his academic career he also worked in the fund management industry for several years.

Received 18 September 2008; Revised 18 September 2008.

Abstract

This paper investigates 1-year-ahead forecasts of actively managed equity mutual funds. A multifactor forecast model is developed that employs forecasts on the manager's skill, the fund's style and the expected factor returns. On the basis of a sample of German equity funds, we show that this forecast model substantially improves forecast power in relation to a naïve forecast model, which just extrapolates past returns into the future. In particular, the multifactor model reduces the mean-squared error (mean absolute error) by up to 30 per cent compared to the naïve model. More importantly, from the perspective of a mutual fund investor, the return of top-decile funds chosen by the multifactor model exceeds the average return of all funds by more than 200 basis points per year.