Swedroe: Turnover, Returns Can Coincide

August 25, 2017

While there has been a strong and persistent trend toward passive investing, actively managed funds still control the lion’s share of assets under management.

Lubos Pastor, Robert Stambaugh and Lucian Taylor contribute to the literature on actively managed mutual funds with their study “Do Funds Make More When They Trade More?”, which appeared in the August 2017 issue of The Journal of Finance. Their research focused on the question of whether active equity fund managers have skill.

To answer it, they examined the trading behavior of actively managed mutual funds. The authors hypothesized: “A fund trades more when it perceives greater profit opportunities. If the fund has the ability to identify and exploit those opportunities, then it should earn greater profit after trading more heavily.”

Turnover & Returns

Their study, which covered 3,126 active U.S. equity mutual funds from 1979 through 2011, benchmarked active fund performance against the index assigned by Morningstar. Following is a summary of their findings:

  • A fund’s turnover positively predicts the fund’s subsequent benchmark-adjusted return. The typical fund performs better after it trades more.
  • Funds holding small company stocks, or small-cap funds, have a significantly stronger turnover-performance relation than large-cap funds.
  • There’s a stronger relation for small funds than large funds, consistent with the ability of smaller funds to trade less-liquid stocks, given that smaller funds tend to trade in smaller dollar amounts.
  • A one-standard-deviation increase in turnover is associated with a statistically significant 0.66% per year increase in performance for the typical fund.
  • The findings are robust in the subperiod 2000 through 2011.
  • The findings were similar when the active funds were benchmarked against the Fama-French three-factor model (market beta, size and value), the Fama-French four-factor model (adding momentum) and the Fama-French five-factor model (market beta, size, value, investment and profitability).

 

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