On Market Timing, Stock Picking, and Managerial Skills of Mutual Fund Managers with Manipulation-Proof Performance Measure

Abstract

The on-going debate over whether fund managers have skills and whether those skills are short-lived is still inconclusive. Using the performance measure that can’t be manipulated with respect to the underlying distribution, time variation, nor estimation error, (the manipulation-proof performance measure (MPPM, Goetzmann et al. (2007)), we rank all U.S. domestic equity mutual funds from 1980 to 2012 on a quarterly basis and analyze their portfolio holding to contribute to the literature in two folds. First, managers ranked highest on MPPM in the current quarter earn largest fee-adjusted fund returns in the following quarter. Those managers hold younger, smaller, lower book-to-market, and momentum stocks. Second, taking long positions of the addition and short positions of the removal from their quarterly holdings from the highest ranked managers would outperform the lowest ranked managers by 12 basis points at the following quarter. Even though higher ranked managers have better stock picking skills, their fund returns are not large enough to offset their frequent transactions and higher expenses to insure positive alphas.

Keywords: manipulation-proof performance measure (MPPM), equity mutual fund, portfolio risk, portfolio characteristics

JEL Classification: G11, G12, G14, G23