Tomorrow Is Another Day: Stocks Overweighted by Active Mutual Funds Predict the Next-Day Market

Abstract

We show that active mutual fund managers effectively incorporate information about future short-term market movements into security prices. Specifically, when high active-mutual-fund ownership stocks outperform, the market tends to do well the next day, and vice-versa. These effects are modest day by day but are quite large in the aggregate - trading the S&P 500 futures daily based on the strategy delivers an average annual return over 15% with a Sharpe ratio over 0.9. The same findings are also present in other major equity markets all around the world. Various additional tests further suggest that the novel short-term market return predictability results from active mutual fund managers' collective information advantage about future market movements, as opposed to informed fund flows or temporary price pressure.

Keywords: Market Predictability, Active Mutual Funds, Market Efficiency

JEL Classification: G10, G14, G17, G23