On the Managerial Skills of Mutual Fund Managers (Manipulation-Proof Performance Measure)

Abstract

The on-going debate over whether fund managers have skills and whether those skills are short-lived is still inconclusive. Using the performance measure that can’t be manipulated with respect to the underlying distribution, time variation, nor estimation error, (the manipulation-proof performance measure (MPPM, Goetzmann et al. (2007)), we rank all U.S. domestic equity mutual funds from 1980 to 2013 on a quarterly basis and analyze their portfolio holdings to generate few insights. First, fund managers in the higher ranked MPPM deciles persistently outperform lower ranked managers by posting higher gross and net fund returns, higher holding-based returns, and generating positive return gap. Second, the characteristic of the holdings indicates higher ranked fund managers would hold younger, smaller, growth, and particularly stocks with lower liquidity and higher information asymmetry. Based on the five-factor (Fama and French (2014)) analysis, our results show that higher ranked managers could generate 15 to 29 basis points while lower ranked managers would loss 20 to 26 basis points on their risk-adjusted ex-post monthly holding returns (alphas) based on their ex-ante constructed holdings. Fourth, the differences on managers of the highest rank and the lowest rank result in monthly risk-adjusted returns (alphas) up to 49 to 52 basis points. Even though the managerial skills are identified at the higher ranked managers, the persistent and the predictability of their superior holding-based returns and fund returns are merely limited to up to six months. We conclude that even though higher ranked managers have better stock picking skills, their net fund returns are not large enough to offset their expenses to warrant positive alphas.