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Abstract:
This paper analyzes the performance of portfolio strategies that invest in no-load, open-end U.S.; domestic equity mutual funds, incorporating predictability in (i) manager skills, (ii) fund risk-loadings, and (iii) benchmark returns. Predictability in manager skills is found to be the dominant source of investment profitability - long-only strategies that incorporate such predictability considerably outperform prior-documented hot-hands and smart-money strategies, and generate positive and significant performance with respect to the Fama-French and momentum benchmarks. Specifically, these strategies outperform their benchmarks by 2-4% per year through their ability to time industries over the business cycle. Moreover, they choose individual funds that outperform their industry benchmarks to achieve an additional 3-6% per year. Overall, our findings indicate that industries are important in locating outperforming mutual funds, and that active management adds much more value than documented by prior studies.

Abstract:
This paper analyzes the performance of portfolio strategies that invest in no-load, open-end U.S. domestic equity mutual funds, incorporating predictability in (i) manager skills, (ii) fund risk-loadings, and (iii) benchmark returns. Predictability in manager skills is found to be the dominant source of investment profitability -- long-only strategies that incorporate such predictability considerably outperform prior-documented "hot-hands" and "smart-money" strategies, and generate positive and significant performance with respect to the Fama-French and momentum benchmarks. Specifically, these strategies outperform their benchmarks by 2-4% per year through their ability to time industries over the business cycle. Moreover, they choose individual funds that outperform their industry benchmarks to achieve an additional 3-6% per year. Overall, our findings indicate that industries are important in locating outperforming mutual funds, and that active management adds much more value than documented by prior studies.

Equity mutual fund, asset allocation, manager skills, business cycle

Abstract:
Mutual fund returns strongly persist over multi-year periods - that is the central finding of this paper. Further, consumer and fund manager behavior both play a large role in explaining these long-term continuation patterns - consumers invest heavily in last-year's winning funds, and managers of these winners invest these inflows in momentum stocks to continue to outperform other funds for at least two years following the ranking year. By contrast, managers of losing funds appear
reluctant to sell their losing stocks to finance the purchase of new momentum stocks, perhaps due to a disposition effect. Thus, momentum continues to separate winning from losing managers for a much longer period than indicated by prior studies.

Even more surprising is that persistence in winning fund returns is not entirely explained by momentum - we find strong evidence that flow-related buying, especially among growth-oriented funds, pushes up stock prices. Specifically, stocks that winning funds purchase in response to persistent flows have returns that beat their size, book-to-market, and momentum benchmarks by two to three percent per year over a four-year period. Cross-sectional regressions indicate that these abnormal returns are strongly related to fund inflows, but not to the past performance of the funds - thus, casting some doubt on prior findings of persistent manager talent in picking stocks. Finally, at the style-adjusted net returns level, we find no persistence, consistent with the results of prior studies. On balance, we confirm that money is smart in chasing winning managers, but that a "copycat" strategy of mimicking winning fund stock trades to take advantage of flow-related returns appears to be the smartest strategy.

mutual funds, market efficiency, performance evaluation

Abstract:
This paper develops a simple technique that controls for “false discoveries,” or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero-alpha, and (3) skilled funds, even with dependencies in cross-fund estimated alphas. We find that 75% of funds exhibit a zero alpha (net of expenses), consistent with the Berk and Green (2004) equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find funds with persistent performance.

Mutual Fund Performance, Multiple-Hypothesis Test, Luck, False Discovery Rate

Abstract:
This paper conducts a comprehensive analysis of the relation between the performance and governance structure of open-end, domestic-equity mutual funds during the 1985 to 2002 period. Specifically, we analyze the role of fund managers in generating portfolio performance, as well as the role of fund boards, both in the ongoing performance of the fund, and in replacing underperforming managers. We find evidence that experienced large-fund managers and managers with better track-records outperform their size, book-to-market, and momentum benchmarks, which indicates that managers play an important role in generating portfolio performance. However, we find that experienced managers of smaller funds underperform their less-seasoned counterparts, indicating the presence of managerial entrenchment in the asset-management industry. When we examine the role of boards, we find that higher numbers of independent directors predict both better future performance and a higher likelihood of underperforming manager replacement, which indicates that the structure of the board is an important determinant of governance quality. Overall, our findings add new insights to the ongoing debate on fund governance.

Mutual Funds, Investment Management, Corporate Governance

Abstract:
This paper conducts a comprehensive analysis of the relation between the performance and governance structure of open-end mutual funds during the 1985 to 2002 period. Specifically, we analyze the role of fund managers in generating portfolio performance, as well as the role of fund boards, both in the ongoing performance of the fund, and in replacing underperforming managers. We find evidence that growth-fund managers with more experience and better track-records outperform their peers, which indicates that manager characteristics are key in explaining portfolio performance for these funds. Further, we find evidence of efficiencies in the labor market for fund managers, in that replaced managers underperform their peers, on average. Specifically, the incoming manager outperforms the replaced manager by one percent per year; in addition, we find that poorly performing fund managers are more likely to be replaced by funds having larger numbers of outside directors on their boards, indicating that the structure of the board is an important determinant of governance quality. However, we also find evidence consistent with manager entrenchment. That is, experienced managers perform well only when they manage large funds - experienced small fund managers underperform their less-seasoned counterparts. Overall, our findings add new insights to the ongoing debate on fund governance.

Mutual Fund Performance, Mutual Fund Managers, Mutual Fund Governance

Abstract:
We analyze the trading activity of the mutual fund industry between 1975 and 1994 to determine whether funds "herd" when they trade stocks and to investigate the impact of herding on stock prices. Although we find little herding by mutual funds in the average stock, we find much higher levels in trades of small stocks and in trading by growth-oriented funds. Stocks that herds buy outperform stocks that they sell by four percent during the following six months; this return difference is much more pronounced among small stocks. Our results are consistent with mutual fund herding speeding the price-adjustment process.

Abstract:
We analyze the trading activity of the mutual fund industry between 1975 and 1994 to determine whether funds "herd" when they trade stocks and to investigate the impact of herding on stock prices. Although we find little herding by mutual funds in the average stock, we find much higher levels in trades of small stocks and in trading by growth-oriented funds. Stocks that herds buy outperform stocks that they sell by four percent during the following six months; this return difference is much more pronounced among small stocks. Our results are consistent with mutual fund herding speeding the price-adjustment process.

Abstract:
We investigate the value of active mutual fund management by examining the stockholdings and trades of mutual funds. We find that stocks widely held by funds do not outperform other stocks. However, stocks purchased by funds have significantly higher returns than stocks they sell-this is true for large stocks as well as small stocks, and for value stocks as well as growth stocks. We find that growth-oriented funds exhibit better stock-selection skills than income-oriented funds. Finally, we find only weak evidence that funds with the best past performance have better stock-picking skills than funds with the worst past performance.

Abstract:
This paper shows that publicly disclosed mutual fund portfolio holdings have investment value. Our approach is based on the intuition that an overweighting by successful managers, or an underweighting by unsuccessful managers signals that a stock is currently underpriced. Investment strategies based on portfolio holdings, weighted by past fund performance, generate returns exceeding seven percent during the following year, adjusted for the size, book-to-market, and momentum characteristics of stocks. The return-predictive power of the models is not explained by the effect of fund herding or fund flows; rather, it is derived largely from the ability to predict firms' future operating profitability. Further, investment signals generated by the models are distinct from a large number of stock return signals documented by existing literature. Our results indicate that some fund managers have persistent skills in uncovering private information on fundamental stock values.

mutual funds, performance persistence, portfolio disclosure, stock selection

Abstract:
This study provides evidence that mutual fund trading in response to the release of analyst information destabilizes U.S. stock prices. Specifically, we show that, during the 1995 to 2006 period, mutual funds "herd" (trade together) into stocks with consensus sell-side analyst upgrades and (especially) herd out of stocks with consensus downgrades. Further, downgraded stocks heavily sold by herds initially underperform, then outperform their size, book-to-market, and momentum benchmarks, while upgraded stocks that are heavily bought exhibit the opposite pattern. An investment strategy that exploits these reversals generates a benchmark-adjusted return exceeding six percent per year. Moreover, the sharpest return reversals occur when mutual funds with poor recent performance ("unskilled fund managers") herd in selling stocks they own in common following a consensus analyst downgrade. The response of herds to analyst revisions and the resulting stock return reversals have both increased from 1985 to 2006, which is consistent with the rapidly increasing proportion of unskilled mutual fund managers over this period. Overall, our evidence indicates that herding by mutual fund managers with short-term reputational concerns in response to the release of sell-side analyst information leads to significant stock return reversals.

mutual funds, stock market efficiency

Abstract:
This paper introduces a new approach to replicating hedge fund returns. Specifically, we use low-frequency (monthly) models to forecast high-frequency (daily) hedge fund returns. This approach addresses the common problem that confronts investors who wish to monitor their hedge funds on a daily basis - disclosure of returns by funds occurs only at a monthly frequency, usually with a time lag. We use monthly returns on investable assets or factors to fit monthly hedge fund returns, then forecast daily returns (using the publicly observed daily returns on the explanatory assets) of hedge funds during the following month. We show that our replication approach can be used to forecast daily returns of long/short hedge funds, and for diversified portfolios such as hedge fund indexes and funds-of-hedge-funds it forecasts daily returns very accurately. We illustrate how our simple replication approach can be used to (1) hedge daily hedge fund risk and (2) estimate and control value-at-risk.

hedge funds, hedging, replication, portfolio management, risk management, VaR

Abstract:
We apply a new bootstrap statistical technique to examine the performance of the U.S. open-end, domestic-equity mutual fund industry over the 1975 to 2002 period. This bootstrap approach is necessary because the cross-section of mutual fund alphas has a complex, non-normal distribution - due to heterogeneous risk-taking by funds as well as non-normalities in individual fund alpha distributions. Our bootstrap approach reveals findings that differ from many past studies. Specifically, we find that a sizable minority of managers pick stocks well enough to more than cover their costs; moreover, the superior alphas of these managers persist.

mutual funds, performance evaluation, bootstrap

Abstract:
This paper studies the effect of share restrictions on the flow-performance relation of individual hedge funds. As such, we reconcile previous research that shows conflicting results for this relation without explicitly considering restrictions. Specifically, we find that hedge funds exhibit a convex flow-performance relation in the absence of share restrictions (similar to mutual funds), but exhibit a concave relation in the presence of restrictions—our evidence is consistent with both a direct effect of the binding restrictions and an indirect effect that is due to investors endogenizing expected future binding restrictions when investing their money. Further, we find that live funds exhibit a concave flow-performance relation due to stricter flow restrictions than defunct funds, which display a convex relation. Finally, we find that money is “smart,” that is, fund flows predict future hedge fund performance; however, this “smart money” effect is eliminated among funds with greater share restrictions.

hedge fund flows, share restrictions, asset illiquidity, life/defunct funds, smart money effect

Abstract:
This paper analyzes the time-series dynamics of closed-end fund discounts and their relation to portfolio performance and manager turnover. We find that a fund underperforms its peer group prior to manager replacement, but improves afterwards. We also find that, prior to replacement, the discount initially increases as fund performance worsens, then stops responding to further poor performance. For domestic equity funds, the peer-adjusted discount first increases by about 5%, then decreases by about 3% by the time of replacement. This pattern is consistent with discount changes reflecting investor learning about fund manager skills, as well as investor anticipation of an impending manager replacement. Finally, we find that discount changes reflect past and forecast future portfolio performance among funds without manager replacements. Overall, our results are consistent with a significant component in closed-end fund discounts being related to manager talent.

Closed-end fund, manager turnover, discount

Abstract:
This study documents evidence consistent with herding in voluntary disclosure decisions in the context of capital expenditure forecasts and investigates two possible reasons for this behavior. Theories of rational herds suggest that herding in disclosure decisions may be due to either (1) the influence of information reflected in peer firms' past disclosure decisions (informational herding), and/or (2) managers' concern for their reputations (reputational herding). Using duration analysis for repeated events, we examine the timing of capital expenditure forecasts for a broad sample of disclosing and nondisclosing firms. We predict and find that the propensity to release capital expenditure forecasts is positively associated with the proportion of prior disclosing firms within the same industry, thus, providing evidence of herding. We also find that this positive association is even higher for firms in highly concentrated industries and firms with low barriers to entry. This finding suggests that firms facing relatively high industry competition may have greater incentives to herd. To provide further evidence of the underlying sources of this behavior, we examine whether the tendency to herd varies with the information content and specificity of prior same-industry forecasts, and with the level of managerial reputation. Our findings show that managers are more likely to disclose their expenditure plans when prior peer forecasts signal a decrease in future capital spending and when prior peer forecasts are more precise. Furthermore, we find that less reputable managers exhibit greater tendencies to herd in their disclosure decisions. These findings indicate that informational and reputational factors are both significant sources of herding in voluntary disclosure decisions.

herding, disclosure

Abstract:
This paper develops a new approach to control for commonalities in actively managed investment fund returns when measuring their performance. Many investment fund managers systematically load on common priced factors that are omitted from popular models, exhibit similarities in their choices of specific stocks and industries, or vary their factor-loadings in a similar way over time. These commonalities create well-known problems in measuring the performance of groups of funds, since it is difficult to control for their correlated residuals in commonly used models. While, in principle, it is possible to add factors to control for these commonalities, the large number of potential strategies used by fund managers make this approach untenable.

In this paper, we propose a simple approach to account for the commonalities in fund strategies that only uses information on fund returns and the investment objective of the fund. Our approach is to form an additional factor from the return on the group of funds to which a given fund belongs. We call this additional factor an "endogenous benchmark," since each fund manager chooses the group within which it intends to compete. This choice of a group by the manager indicates the set of strategies from which the manager will choose in order to compete.

Using only the returns and investment objectives of funds, our endogenous benchmarks substantially reduce the cross-sectional dependencies of residuals, across groups of funds and across individual funds within a group. Specifically, more than half of the cross-sectional correlations between individual funds is eliminated with our method. We also show that this improvement in estimation of alphas results in a better identification of U.S. equity and fixed-income funds with persistent performance. For instance, relative to a standard four-factor model, our model generates outperformance of more than 3% per year among U.S. growth equity funds.

Abstract:
This paper develops a new approach that controls for commonalities in actively managed investment fund returns when measuring their performance. It is well-known that many investment funds may systematically load on common priced factors omitted from popular models, exhibit similarities in their choices of specific stocks and industries, or vary their risk-loadings in a similar way over time. We propose a parsimonious model that uses the return on the group of mutual funds as a benchmark for each individual fund within that group. We demonstrate that this model substantially reduces the correlation between fund residuals from standard models used for equity and fixed-income funds, and improves the estimates of fund alpha's and beta's from commonly used equity and fixed-income models.

Abstract:
Despite significant growth in the European mutual fund industry and the integration of European financial markets during recent years, the performance of European equity mutual funds is largely an unexplored area of research. This paper shows that macroeconomic state variables can be used to identify a significant time-varying alpha component among a large sample of funds with a Pan-European, European country, or European sector focus. Specifically, the default yield spread, term spread, dividend yield, and short interest rate, as well as macroeconomic variables tracking consumer price inflation and economic sentiment prove valuable in identifying, ex-ante, funds with superior performance. Most of the alpha that these state variables generate comes from their ability to identify superior Pan-European funds, as well as to generate returns from country selection.

European mutual funds, four factor model, Bayesian analysis, risk-adjusted performance

Abstract:
We use a new database to perform a comprehensive analysis of the mutual fund industry. We find that funds hold stocks that outperform the market by 1.3 percent per year, but their net returns underperform by one percent. Of the 2.3 percent difference between these results, 0.7 percent is due to the underperformance of non-stock holdings, while 1.6 percent is due to expenses and transactions costs. Thus, funds pick stocks well enough to cover their costs. Also, high-turnover funds beat the Vanguard Index 500 fund on a net return basis. Our evidence supports the value of active mutual fund management.

Abstract:
We examine the investment strategies of 155 mutual funds over the 1975-84 period to determine the extent to which the funds purchased stocks based on their past returns, and to determine the relation of this behavior to their observed portfolio performance. We find that about 77% of these mutual funds were "momentum investors", buying stocks that were past winners; however, they did not systematically sell past losers. On average, these "trend-followers" realized significantly better performance than the remaining funds. We also find that the mutual funds exhibited herding behavior, and that the tendency of a fund to herd in its trades was strongly correlated with its tendency to buy past winners as well as with its portfolio performance. Consistent with the evidence on trend-following, herding into past winners was stronger than herding into past losers.

Abstract:
We analyze the portfolio holdings of mutual funds over the 1975-84 period to detect whether the funds engaged in "herding" (simultaneous same-direction trading by a group of funds), "cascading" (sequential same-direction trading by two groups of funds---one following the other), or "trade reversals" (sequential opposite-direction trading by a single group of funds). Our results suggest the presence of herding behavior and short-term trade reversals, especially among the top performing funds; the funds especially exhibited herding behavior in stocks with high past returns. In addition, stocks that the funds bought as a herd had significantly higher abnormal returns, during the following quarters, than stocks that the funds sold as a herd. Finally, we find evidence of some groups of funds cascading their portfolio choices on the prior portfolio choices of other funds, in stocks with a large number of the 274 funds involved in trading.