Abstract
Inspired by the residual income model used to assess firms’ value creation in the accounting field, we provide a new estimation approach to infer a fund's skills, value creation, and whether the value created by funds can predict future performance. Using a sample of 2069 active equity funds in China from 2011 to 2022, as predicted by this model, we find that the residual earnings of funds, which represent the value created through fund trading activities, are persistent. Additionally, we observe a strong and positive relationship between residual earnings and semi-year-ahead mutual fund abnormal returns. Specifically, the top quintile portfolio based on residual earnings outperforms the bottom quintile by 2.16 % abnormal returns per year. Furthermore, we note that Chinese mutual funds with higher residual earnings tend to be younger, smaller, and have substantial turnover. These findings are valuable for fund investors seeking to identify high-value funds.
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