An Empirical Investigation of Short-Selling by Actively Managed Mutual Funds

Abstract:     
In this paper, we provide a first look at mutual funds that used short sales of US domestic stocks as an investment strategy. The shorted stocks tend to be glamour stocks with high accruals, indicating that mutual funds are sensitive to the information in valuation and earnings quality related indicators. We find that the shorted stocks significantly underperform subsequently. Using detailed portfolio holdings data, we show that the sample funds generate significant abnormal performance from both their short and long investments, which suggests that the act of short selling is an indicator of managerial skill. Mutual fund investors appear to be cognizant of this skill, and reward the funds that engage in short selling with abnormally large inflows of new money in the month when the fund first reports short positions and in the subsequent twelve months.

Keywords: Mutual fund, Performance evaluation, Short sales

JEL Classifications: G2, G12, G14

Working Paper Series