Rational Cross-Sectional Differences in Market Efficiency: Evidence from Mutual Fund Returns by PAUL H. SCHULTZ University of Notre Dame - Department of Finance & Business Economics November 14, 2007 Abstract: There should be enough inefficiency in the market to allow returns to security analysis to adequately compensate the marginal investor for his efforts. Cross-sectional differences in the costs of analysis imply cross-sectional differences in market efficiency. Small growth stocks are especially costly to analyze and trade. Hence we would expect that the returns before expenses that smart investors earn analyzing these stock to be especially high. Over 1980 - 2006, the small growth stocks held by active mutual funds earn average abnormal returns of 0.76% per month. Large value stocks held by funds earn monthly abnormal returns of only 0.05%.
Keywords: market efficiency, mutual funds, growth stocks, small stocks JEL Classifications: G12, G14, G20
If the conclusions of the paper above are correct (I have not had time to read it yet), actively managed mutual make more sense for small cap growth stocks than for large cap value stocks. I have seen similar research for small cap vs. large cap stocks, ignoring the value/growth dimension.