A First Look at Mutual Funds That Use Short Sales

Abstract

The use of short sales by mutual funds has increased significantly over the last decade. In this paper, we provide a first look at short selling by mutual funds, a phenomenon not examined by prior research. The mutual funds that use short sales do so frequently and in significant amounts, averaging about 16% of fund assets. We find that mutual funds that use short sales outperform size-matched control funds by a risk-adjusted 1.5% per year, suggesting that managers using short sales are skilled. The results are similar when we use style and size-matched funds. Using detailed portfolio holdings data, we show that mutual funds that use short sales generate abnormal performance from both their short (4.1% per year) and long (1.5% per year) positions. Furthermore, fund managers who use short sales exhibit superior performance in other funds they manage that do not use short sales. Our findings thus suggest that managers of mutual funds that use short sales appear to possess skill.