The Sources of Portfolio Volatility and Mutual Fund Performance
48 Pages Posted: 11 Mar 2023
We conduct a volatility decomposition to identify the source of performance differences between low volatility and high volatility mutual funds. Our procedure demonstrates how security-level variances and covariances lead to idiosyncratic volatility effects at the portfolio level. We show that a measure constructed from the average covariances of securities in a fund’s portfolio is sufficient to characterize the portfolio-level idiosyncratic volatility effect. In contrast, the security-level variances of funds’ holdings are only weakly associated with the idiosyncratic volatility effect but are closely tied to a fund’s exposure to the beta anomaly.
Keywords: Mutual funds, return volatility, fund manager skill, beta anomaly, return covariance
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