The sources of portfolio volatility and mutual fund performance

Abstract

We conduct a volatility decomposition to identify the source of performance differences between low volatility and high volatility mutual funds. A higher level of return covariance of fund holdings is associated with more fund-level exposure to the idiosyncratic volatility effect. Average security-level variance of fund holdings is only weakly associated with idiosyncratic volatility. However, the average security-level variance of a fund’s holdings is closely tied to a fund’s exposure to the beta anomaly. We demonstrate that our measure of the within-portfolio covariance of fund holdings is useful in evaluating fund-level performance measures and exposure to volatility anomalies.

Keywords: intermediary-led asset pricing, mutual funds, return volatility, fund manager skill, volatility anomalies, market efficiency, portfolio returns

JEL Classification: G11, G12, G14, G20