Do Funds Make More When They Trade More?
51 Pages Posted: 24 Nov 2014 Last revised: 24 Jul 2023
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Do Funds Make More When They Trade More?
Do Funds Make More When They Trade More?
Do Funds Make More When They Trade More?
Do Funds Make More When They Trade More?
Date Written: November 2014
Abstract
We model optimal fund turnover in the presence of time-varying profit opportunities. Our model predicts a positive relation between an active fund’s turnover and its subsequent benchmark-adjusted return. We find such a relation for equity mutual funds. This time-series relation between turnover and performance is stronger than the cross-sectional relation, as the model predicts. Also as predicted, the turnover-performance relation is stronger for funds trading less-liquid stocks, such as small-cap funds. Turnover has a common component that is positively correlated with proxies for stock mispricing, consistent with funds exploiting time-varying opportunities. Turnover’s common component helps predict fund returns.
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