Skill and Value Creation in the Mutual Fund Industry
48 Pages Posted: 31 Oct 2018 Last revised: 25 May 2019
Date Written: May 9, 2019
We develop a simple, nonparametric approach for estimating the entire distribution of skill. Our approach avoids the challenge of correctly specifying the distribution, and accommodates the need to study both the investment and trading dimensions of skill. Our results show that most funds are skilled at detecting profitable trades, but unskilled at overriding capacity constraints. Aggregating both skill dimensions, we find overwhelming evidence that mutual funds produce significant value added. In addition, the active industry is (i) not concentrated because few funds are skilled on all dimensions, (ii) close to optimally sized as funds internalize the impact of capacity constraints, and (iii) in a strong bargaining position vis-a-vis the investors.
Keywords: Mutual fund skill, non-parametric density estimation, large panel
JEL Classification: G11, G12, C14, C33, C58
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