Working Paper: NBER ID: w20700
Authors: Lubos Pastor; Robert F. Stambaugh; Lucian A. Taylor
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.
Keywords: mutual funds; fund turnover; performance; active management; liquidity
JEL Codes: G10; G20; J24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal fund turnover (G11) | subsequent returns (I26) |
| funds that trade more (G23) | perform better (D29) |
| one-standard-deviation increase in turnover (J63) | 0.65% annual increase in performance (G12) |
| common component of turnover (J63) | predict fund returns (G17) |
| higher turnover (J63) | stronger performance for less liquid stocks (G19) |
| turnover during high sentiment or low liquidity (G14) | correlation with profit opportunities (C10) |