Question

Explain how you would conduct tests for whether mutual fund managers have skill. What
have tests for the existence of fund managers skill found? 20/100 marks

Focusing on Fama and French paper mutual fund performance 2008

Answer 1

Ans.

The portfolio managers are intuitively aware of the importance of effective selling to fund performance and they often claim to follow explicit selling disciplines, the process of selling is, in fact, much less rigorous, compared to buying . Buy decisions tend to be highly disciplined and involve rigorous analysis and structured research processes. Most importantly, place the fund manager mentally in the prospective “gain” domain.

Conduct test of differential buying and selling skills we focus on the ability of fund managers to capitalize on different market conditions and to exploit time-varying expected returns of stock characteristics including the size, book-to-market, and momentum factors by adjusting his or her portfolio appropriately.

One possible reason for lack of evidence supportive of fund manager timing performance is that existing research has concentrated on investigating whether mutual fund managers have timing ability by testing timing performance in aggregate which might not necessarily be a good indicator of the timing skills mutual fund managers actually possess such as buying and selling abilities

Mutual fund holdings to explore directly whether increases or decreases in portfolio weightings along the three stock characteristics of size, book-to-market, and momentum effect, can forecast future returns, respectively. Our holding-based method allows us better to capture the dynamic aspects of actively managed portfolios but also avoid the “artificial timing” and other biases that are usually found in return-based measures.

When the investigate trading performance persistence in the buy and sell domains separately, we find that good buyers continue to be good buyers for at least the following three quarters while bad buyers in any quarter do not continue to exhibit negative buying skill in subsequent quarters.

Conversely, bad sellers continue to be bad sellers while good sellers do not continue to outperform. In other words, extremely poor characteristic-timing performance for buying seems to be due to bad luck, whereas extremely good performance for selling appears to be driven by good luck.

The fund managers might possess different trading skills. We speculate that, since selling decisions are more susceptible to behavioral bias, fund managers who make sell decisions in a more disciplined and research-based way may also have better buying skills.differential trading skills among a small number of “star” growth-oriented mutual fund managers. However, their analysis can be criticised, inter alia, for potentially overestimating the trading skill of their “successful” growth-oriented mutual fund managers.

(a)Measuring Buying and Selling Characteristic-Timing Performance:-

The mostly based on non-linear regressions of realised fund returns against contemporaneous market returns (return-based measures), have been challenged for potential estimation problems. First, most existing studies assume that timing strategies are implemented in a specific way, which can limit the test power of return-based measures to detect timing ability if fund managers choose to time in a more complex manner.

The fund manager timing ability based on mutual fund portfolio holdings (holding-base measures), there is still no convincing empirical evidence to show that mutual fund managers are able to successfully time the market or exploit time-varying stock characteristic returns.

the characteristic-timing measure, suppose that a fund increases its weight in high book to-market stocks at the beginning of the month in which the book-to-market effect is unusually strong, then this fund would have positive characteristic-timing performance

The characteristic-timing performance for the buy sub-portfolio will be positive; if sales of stocks are associated with subsequent returns higher than prior average returns from stock characteristics, the characteristic-timing performance for the sell sub-portfolio will also be positive.

(b)Trade Motivation Relate to Trade Performance:-

The fund managers liquidity process to engage in costly trading. In particular, when experiencing fund outflows, fund managers often have no other options but to sell some of their existing holdings to fulfil investor redemption requirements, even when they might believe that those stocks are undervalued.

In case of any negative characteristic-timing performance when selling stocks is driven by liquidity-induced sales. This sub-section attempts to address this question. We separate fund managers’ motivations for trading by conditioning fund purchases and sales on the motivation score metrics.

The fund managers having superior buying skill and another group specialising in selling, or a small subset of fund managers performing both successfully. In particular, in this subsection, we test whether the best buyers may nonetheless have good selling skill

The good sellers are able to time stock characteristics well also when buying stocks, then these fund managers should also outperform other funds in terms of aggregate characteristic-timing performance, whereas good buyers who are good at buying but with no selling skill might not be able to earn superior returns.

Conclusion:-

The mutual fund managers, a representative group of professional investors, exhibit investment abilities, and in particular whether they have factor-timing skill and are able to adjust portfolio exposure to the risk factors of size, book-to-market and momentum effects appropriately.

The fund managers do not possess characteristic-timing ability on average, in fact, we find there is even a sub-set of managers who manifest poor timing ability that persistently destroys overall portfolio value. However, fund managers also exhibit a “striking” ability to sell stocks at the wrong time: their selling decisions are associated with negative subsequent characteristic-timing performance

Focusing on valuation-motivated trades, we find that, fund managers who have the greatest selling ability also exhibit superior characteristic-timing performance when buying stocks compared with all other funds the fund managers may have different trading skills.

Even for professional investors, sell decisions are particularly difficult. Future work might explore the mechanisms by which behavioural factors could drive poor selling performance.