Style and Skill: Hedge Funds, Mutual Funds, and Momentum

Abstract

Institutional 13F stockholdings reveal stark differences between the investment philosophy and skill of hedge funds and mutual funds. Hedge funds tend to buy stocks with low past returns, while mutual funds tend to be trend followers. The two-thirds of hedge funds that follow contrarian strategies are the only fund category that generates a positive alpha, outperforming their risk- and characteristic-adjusted benchmarks by 2.4% per year. Contrarian hedge funds tend to be on the correct side of the trade in their interactions with all other fund types, and their most profitable trades are purchases of stocks sold by momentum mutual funds and momentum hedge funds. The superior performance of contrarian hedge funds is persistent and arises from strategies that are more complex than purchasing stocks with low past returns. Aggregate stock-by-stock short sales further support the existence of superior investment skills among contrarian hedge funds.

Keywords: Hedge funds, mutual funds, momentum, contrarian, anomalies, stock-picking skill

JEL Classification: G12, G14, G23