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Abstract
We investigate the value of active mutual fund management by examining the stockholdings and trades of mutual funds. We find that stocks widely held by funds do not outperform other stocks. However, stocks purchased by funds have significantly higher returns than stocks they sell-this is true for large stocks as well as small stocks, and for value stocks as well as growth stocks. We find that growth-oriented funds exhibit better stock selection skills than income-oriented funds. Finally, we find only weak evidence that funds with the best past performance have better stock-picking skills than funds with the worst past performance.
I. Introduction
Over $5.5 trillion are currently managed by the U.S. mutual fund industry, with roughly $3 trillion managed in equity funds. A significant portion of this amount is actively managed by money managers who presumably rely on superior stock selection skills to outperform passive strategies. Several billion dollars per year are expended by these active fund managers in pursuit of underpriced stocks, well in excess of the amount that is typically expended by their passive, index fund counterparts.
Although investors seem to trust the ability of these mutual fund managers to invest their savings, academics have repeatedly questioned the ability of funds to systematically pick underpriced stocks. Starting with Jensen ( 1968), many studies claim that the net return provided by the average actively managed mutual fund is inferior to that of a comparable passive benchmark. While the evidence supportive of mutual fund managers possessing stock selection talents is weak, it is possible that these tests, which are based on aggregate mutual fund holdings, are not sufficiently powerful to detect such talents. For example, mutual fund holdings, in aggregate, account for between 3 and 13% of the market value of all publicly traded stocks in the U.S. between 1975 and 1994; hence, it is unlikely that the funds, as a group, hold stocks that outperform their benchmarks by a large amount.
To enable more powerful tests of the stock selection abilities of fund managers, we examine the performance of stocks held by mutual funds as well as stocks actively traded by the funds. Examining the performance of stocks held and traded by mutual funds focuses on the issue of whether the...