Objectives, Data and Methodology

Abstract

It is now widely recognized in the literature that equity mutual fund performance net of costs does not persist in the long run among both winner (recent outperformers) and loser funds (recent underperformers), once survivorship bias and stock return momentum are taken into account. For outperformers, the traditional explanation for this phenomenon is the absence of genuine management skill, apart from slight cross-sectional differences in fee levels. Rather, winner-fund managers happened by luck to hold the last year’s winner stocks benefiting from stock return momentum but cannot successfully pick this year’s winner stocks. Although the majority of loser funds continue to significantly underperform their benchmarks, indicating that any persistence is clustered around loser funds, their performance over time still improves significantly the following year and is also dominated by a strong tendency to revert to the mean (Brown and Goetzmann, 1995; Carhart, 1997). This can be interpreted as evidence that loser-fund managers ended up in a low ranking in the previous year mainly due to bad luck and only to a smaller degree due to bad skills. These findings are consistent with the view that the dominant determinant of fund performance is luck, which per se is not persistent, rather than skill.