Active Sector Funds and Fund Manager Skill
42 Pages Posted: 15 Aug 2018 Last revised: 22 Dec 2019
Date Written: November 17, 2019
We investigate the performance of active sector funds whose potential outperformance has not been exhausted entirely by decreasing returns to scale. We document that despite of good track records, most sector funds are relatively smaller than their equilibrium fund sizes — at which they are expected to generate zero net alphas. In particular, from 1998 to 2016, a passive indexation strategy of actively managed sector funds earns an annual benchmark-adjusted return of 5.70% and a monthly alpha of 27 basis points. Moreover, the strategy’s outperformance is present in market downturns (i.e., resilient to tail risk) and robust to change of rebalancing frequency and inclusion of expenses. We provide one alpha arithmetic as an explanation for the strategy’s success and as a principle for creating similar portfolio strategies.
Keywords: alpha, managerial skill, mutual funds, passive investing
JEL Classification: G11, G20, G23
Suggested Citation: Suggested Citation