Do Active Funds Do Better in What They Trade?

Abstract

We develop two new, simple measures to quantify active fund decisions at the individual position level. The intuition is to separate passive rebalancing induced by flows and position changes from active rebalancing decisions. We find that additive active rebalancing -- both for existing and new positions -- predicts higher stock-level alpha over the following quarter. We show our results are not driven by mechanical price pressure, and provide some evidence that funds may trade on forecasts for future earnings. Our findings are strongest when funds have inflows, for funds that hold fewer stocks, and in positions with large embedded gains and long holding periods. We aggregate our stock-level measure up to the portfolio level, and show that actively adding to positions translates to outsized returns for fund investors.

Keywords: Mutual Funds, Active Management

JEL Classification: G11, G23