Acting on the Most Valuable Information: 'Best Idea' Trades of Mutual Fund Managers

45 Pages Posted: 24 Mar 2008 Last revised: 23 Mar 2009

Date Written: March 17, 2009

Abstract

In this paper, I identify "best idea" trades of fund managers. These trades account for about 30% of fund volume and outperform benchmarks and other fund trades by as much as 47 basis points per month. I identify such trades using an ex ante proxy that does not rely on any performance-related variables and is instead based on common trades of managers with similar information sets. The performance of best ideas is not explained by herding, short-term liquidity pressures, changes in the index composition, or funds' reaction to analyst revisions, and does not revert in the long term. The remaining fund trades (not best ideas) fail to beat passive benchmarks even before expenses, e.g., their average characteristic-adjusted return is statistically insignificant 0.03% per month. Finally, best ideas also improve funds' after-fee returns: Funds which participate in best idea trades beat other funds by up to 0.3% per quarter.

Keywords: mutual funds, management companies, portfolio choice, skill

JEL Classification: G11, G14, G23

Suggested Citation

Pomorski, Lukasz, Acting on the Most Valuable Information: 'Best Idea' Trades of Mutual Fund Managers (March 17, 2009). Available at SSRN: https://ssrn.com/abstract=1108186 or http://dx.doi.org/10.2139/ssrn.1108186

Lukasz Pomorski (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

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