Skewness Consequences of Seeking Alpha

Abstract

Mutual funds seek alpha, but coskewness is also an important performance attribute. Alpha and coskewness relative to the market are negatively correlated in theory, so funds may generate undesirable coskewness in the pursuit of alpha. Empirically, the tradeoff exists for mutual funds and is driven by both average fund composition and other actions of managers. After alphas are adjusted for coskewness, fewer funds have significantly positive performance than one would expect by chance. Proxies for active management associated with positive alphas are also associated with undesirable coskewness. Money flows to funds with desirable coskewness.

Keywords: Performance evaluation, coskewness, skewness, mutual fund

JEL Classification: G11, G20, G23