Review of Asset Pricing Studies
Mutual fund returns are significantly related to stock characteristics in the cross section after controlling for risk via factor models. We develop a new double-adjusted approach that controls for both factor-model betas and stock characteristics in one performance measure. The new measure substantially affects performance rankings, with a quarter of funds experiencing a change in percentile ranking greater than ten. Double-adjusted performance produces strong evidence of persistence in relative performance. Inference based on the new measure often differs, sometimes dramatically, from that based on traditional performance estimates.
We study the interdependencies between transaction costs, portfolio characteristics, and mutual fund performance. Using a novel dataset of actual mutual fund trades, we find that, controlling for investment style, larger funds realize lower percentage transaction costs than smaller funds. Larger mutual funds trade less frequently and hold bigger stocks to actively avoid incurring higher trading costs. Gross returns of larger funds are lower than those of smaller funds due, in part, to the characteristics of their holdings, which suggests that decreasing returns to scale could arise due to limited investment opportunities because of trading cost constraints. Taken together, our results highlight the tradeoffs faced by mutual funds between trading costs, portfolio characteristics, and fund performance as they grow in size.
Review of Financial Studies
We construct a new measure of trading regularity, capturing the extent to which investors trade on a regular basis. Institutional investors that regularly trade outperform those that trade less regularly. The performance of funds that regularly trade persists for at least a year. Among those who trade most regularly, larger funds perform relatively worse, because they incur higher transaction costs associated with their larger trades. Institutions that regularly trade generate superior performance, in part, by behaving as contrarians and by trading more aggressively on information. By contrast, we find no relation between trading regularity and performance among index funds.