Fund Performance and Subsequent Risk: A Study of Mutual Fund Tournaments Using Holdings-Based Measures

Abstract

The tournament hypothesis of Brown et al. (1996) posits that managers of poorly performing funds actively increase portfolio risk in the second half of the year. At the same time, it is a well-established stylized fact that stock returns and the subsequent return standard deviation are negatively related. We propose a decomposition of fund return standard deviation for the second half of the year using holdings-based measures in order to distinguish between risk changes that result from holding the portfolio and those that are due to the trades of managers. To this end, we extend the return gap of Kacperczyk et al. (2008) to the return standard deviation dimension and define the volatility gap as the difference between fund return volatility and buy-and-hold portfolio volatility. Our empirical findings show that changes in the return volatilities of equity mutual funds are largely explained by shifts in buy-and-hold portfolio volatility. Thus, we find only weak evidence of tournament behavior among mutual funds.

Keywords: Mutual funds, tournament, risk shifting, holdings-based measure

JEL Classification: G11, G12, G14