Can Mutual Fund Managers Pick Stocks? Evidence from their Trades Prior to Earnings Announcements

Abstract

We measure the stock-picking skill of mutual fund managers based on the returns realized around the subsequent earnings announcements of the stocks that they hold and trade. Relative to standard methodologies, this approach exploits the most informative segments of the returns data and ameliorates the joint hypothesis problem inherent in tests of stock-picking skill. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. According to our measures of skill, certain funds perform persistently better than others, and the best performers tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers. * We thank Marcin Kacperczyk, Andrew Metrick, Lasse Pedersen, Robert Stambaugh, and seminar participants and New York University and Yale University for helpful comments. We thank Christopher Blake and Russ Wermers for assistance with data. Baker gratefully acknowledges financial support from the Division of Research of the Harvard Business School. Can mutual fund managers pick stocks? Evidence from their trades prior to earnings announcements February 16, 2005 AbstractWe measure the stock-picking skill of mutual fund managers based on the returns realized around the subsequent earnings announcements of the stocks that they hold and trade. Relative to standard methodologies, this approach exploits the most informative segments of the returns data and ameliorates the joint hypothesis problem inherent in tests of stock-picking skill. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. According to our measures of skill, certain funds perform persistently better than others, and the best performers tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers.

Are Transient Institutions Sophisticated Enough to Interpret Small Negative Earnings Surprises?

“…These results suggest that transient institutions obtained information regarding the impending break from private communications with management. Baker, Litov, Wachter, and Wurgler (2010) investigate institutional investors’ trading around earnings announcements. Baker et al find that the average fund’s recent buys significantly outperform its recent sells around the next earnings announcement, and that this accounts for a disproportionate fraction of the total abnormal returns to fund trades estimated in prior work.…”

Rational Cross-Sectional Differences in Market Efficiency: Evidence from Mutual Fund Returns

“…An alternative approach to testing whether funds are able to find mispriced securities is used by Baker, Litov, Wachter, and Wurgler (2010). They identify stocks that funds have bought and sold and examine the returns of these stocks around their next earnings announcement.…”

Limited attention and portfolio choice: The impact of attention allocation on mutual fund performance

“…Various studies posit that a typical actively managed U.S. equity fund underperforms by earning negative after‐cost alphas (see, e.g., Carhart, 1997; Fama & French, 2010; French, 2008; Gruber, 1996). Others have refuted the evidence on underperformance, with some studies focusing on identifying skilled managers (see, e.g., Amihud & Goyenko, 2013; Baker, Litov, Wachter, & Wurgler, 2010; Berk & van Binsbergen, 2015; Cremers & Petajisto, 2009; Kacperczyk & Seru, 2007; Kacperczyk, Sialm, & Zheng, 2005, 2008; Koijen, 2014; Kosowski, Timmermann, Wermers, & White, 2006; Pastor & Stambaugh, 2002; Pástor, Stambaugh, & Taylor, 2015; Wermers, 2000). Although much of the literature has focused on measuring the performance of actively managed funds and what it implies about skill, less is known about the portfolio‐level actions of managers that generate performance and lead at least some funds to underperform.…”