Mutual Fund Stock-Picking Skill: New Evidence from Valuation versus Liquidity-Motivated Trading
Financial Management 2018, 47(2), 309-347
44 Pages Posted: 26 Nov 2015 Last revised: 13 Jun 2018
Date Written: June 4, 2018
We propose a novel Trade Motivation Matrix (TMM) that allows differentiating funds’ valuation-motivated (VM) and liquidity-motivated (LM) trades on single trade level. It thus enables analyses of stock-picking skill on three levels: trade, stock, and fund. On trade level, we find significant outperformance of VM buys and significant underperformance of VM sells, indicating manager stock-picking skills, especially during illiquid market periods. VM trades outperform LM trades, confirming negative performance effects due to flow risk, especially when market liquidity is low. On stock level, collective VM buying explains high future stock returns while collective VM selling is related to future losses, indicating wisdom of the crowd. On fund level, higher trading discretion, measured by a higher degree of VM trading, is observed for smaller, older funds holding higher cash buffers. Finally, higher trading discretion is related to higher future fund alpha, especially during illiquid times.
Keywords: Mutual fund trading, valuation, liquidity, skill, flow risk, wisdom of crowds
JEL Classification: G11, G20, G23
Suggested Citation: Suggested Citation