Information and Implementation: Assessing the Net Impact of Trading on Mutual Funds
29 Pages Posted: 27 May 2011
Date Written: May 23, 2011
Studies examine the relation between mutual fund performance and trading cost using a variety of proxies - the most common being portfolio turnover. Overall, the evidence is consistent with informational equilibrium, i.e., trading has zero net impact on performance. We offer an alternative explanation, that common trade cost proxies lack statistical power. We show that a necessary condition for statistical power that common trading cost proxies such as turnover fail to satisfy: the proxy must jointly reflect both the volume and per unit cost of trading. Using this observation we develop a simple proxy for trading cost that sorts performance differences of 233 bps per year across fund quartiles, and forecasts fund returns better than past performance, fund size, expense ratios, or other proxies for trading cost.
Keywords: Mutual fund, trading costs, turnover
JEL Classification: G11, G20, G24
Suggested Citation: Suggested Citation