The devil in the style: Mutual fund style drift, performance and common risk factors

Abstract

Style drift contributes to mutual fund performance at the cost of additional risks associated with styles. We find that, although style drift enhances the net return of Chinese mutual funds by 3.03% per month relative to peer funds, the profit is at risk. That is, applying the Carhart four-factor model with style drift leaves fund investors no significant premium (i.e. α=0.02% per month, t=0.20). Both active and passive style drifts can leverage up fund performance, but risk-adjusted returns show that low passive style drift funds benefit more from subsequent active style drifts than high passive style drift funds. Cross-sectional results are consistent with portfolio results, and further show that the predictive power of style drift is neither driven by insider information nor by idiosyncratic volatility.