Can mutual fund investors benefit from volatility managing? Evidence from China

Abstract

Using a comprehensive sample of Chinese mutual funds from 2004 to 2021, we find strong evidence that managing the intertemporal total (downside) risk of actively managed equity mutual funds significantly improves the performance in terms of alphas, Sharpe ratios, and Sortino ratios. Each volatility-managed strategy studied in this paper can survive transaction costs. By testing the relation between risk and return of mutual funds, we find the gains from managing the total (downside) volatility are attributed to both volatility timing and return timing. Empirical results are robust to alternative measurements of total (downside) volatilities, leverage constraints, rebalancing frequency, factor models, sample filters, and a portfolio of all mutual funds. There is no obvious relationship between fund flows and past fund total volatility in the Chinese fund market. However, after dividing the total volatility into upside and downside volatility, the fund flows are positively (negatively) related to the upside (downside) volatility, and these relations are more pronounced for institution-dominated funds.