each investment class to the managers of each fund. Shareholders hope that these portfolio managers can achieve better investment perfor- mance than they could obtain on their own. What is the investment record of the mutual fund industry? This seemingly straightfor- ward question is deceptively difficult to answer because we need a standard against which to evaluate performance. For example, we clearly would not want to compare the invest- ment performance of an equity fund to the rate of return available in the money market. The vast differences in the risk of these two markets dictate that year-by-year as well as av- erage performance will differ considerably. We would expect to find that equity funds out- perform money market funds (on average) as compensation to investors for the extra risk incurred in equity markets. How then can we determine whether mutual fund portfolio managers are performing up to par given the level of risk they incur? In other words, what is the proper benchmark against which investment performance ought to be evaluated? Measuring portfolio risk properly and using such measures to choose an appropriate benchmark is an extremely difficult task. We devote all of Parts II and III of the text to is- sues surrounding the proper measurement of portfolio risk and the trade-off between risk and return. In this chapter, therefore, we will satisfy ourselves with a first look at the ques- tion of fund performance by using only very simple performance benchmarks and ignoring the more subtle issues of risk differences across funds. However, we will return to this topic in Chapter 12, where we take a closer look at mutual fund performance after adjusting for differences in the exposure of portfolios to various sources of risk. Here we use as a benchmark for the performance of equity fund managers the rate of re- turn on the Wilshire 5000 Index. Recall from Chapter 2 that this is a value-weighted index of about 7,000 stocks that trade on the NYSE, Nasdaq, and Amex stock markets. It is the most inclusive index of the performance of U.S. equities. The performance of the Wilshire 5000 is a useful benchmark with which to evaluate professional managers because it cor- responds to a simple passive investment strategy: Buy all the shares in the index in pro- portion to their outstanding market value. Moreover, this is a feasible strategy for even small investors, because the Vanguard Group offers an index fund (its Total Stock Market Portfolio) designed to replicate the performance of the Wilshire 5000 index. The expense ratio of the fund is extremely small by the standards of other equity funds, only .25% per year. Using the Wilshire 5000 Index as a benchmark, we may pose the problem of evaluat- ing the performance of mutual fund portfolio managers this way: How does the typical per- formance of actively managed equity mutual funds compare to the performance of a passively managed portfolio that simply replicates the composition of a broad index of the stock market? By using the Wilshire 5000 as a benchmark, we use a well-diversified equity index to evaluate the performance of managers of diversified equity funds. Nevertheless, as noted earlier, this is only an imperfect comparison, as the risk of the Wilshire 5000 portfolio may not be comparable to that of any particular fund. Casual comparisons of the performance of the Wilshire 5000 index versus that of pro- fessionally managed mutual fund portfolios show disappointing results for most fund man- agers. Figure 4.3 shows the percentage of mutual fund managers whose performance was inferior in each year to the Wilshire 5000. In more years than not, the Index has outper- formed the median manager. Figure 4.4 shows the cumulative return since 1971 of the Wilshire 5000 compared to the Lipper