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. Higher return covariances between fund holdings is associated with more fund-level exposure to the idiosyncratic volatility effect. The average security-level variance of fund holdings is only weakly associated with idiosyncratic volatility but 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: Mutual Funds, return volatility, fund manager skill, beta anomaly, return covariance, mutual fund holdings