Abstract
This study introduces a new measure of portfolio holdings that has power to explain future fund abnormal returns. This measure is defined as on portfolio innovation. It is constructed as the return on completely new portfolio positions that a fund has not held before. I evaluate the return on newly added positions because their performance can signal the quality of managerial effort. On average, a one-standard deviation increase in the return on innovation increases the Carhart (1997) four-factor fund alpha by approximately 0.34 to 0.52 percent per year. In addition, although overall fund performance is inversely related to future risk-taking, higher returns on innovation are associated with greater risk. The results have important implications for fund performance and manager behavior.
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