Hostname: page-component-5d59c44645-hb754 Total loading time: 0 Render date: 2024-02-24T15:25:39.671Z Has data issue: false hasContentIssue false

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

Published online by Cambridge University Press:  02 August 2010

Malcolm Baker
Affiliation:
Harvard Business School, Soldiers Field, Boston, MA 02163, and NBER. mbaker@hbs.edu.
Lubomir Litov
Affiliation:
Washington University in St. Louis, Olin Business School, Campus Box 1133, St. Louis, MO 63130. litov@wustl.edu.
Jessica A. Wachter
Affiliation:
University of Pennsylvania, Wharton School, 3620 Locust Walk, Ste. SH-DH 2300, Philadelphia, PA 19104, and NBER. jwachter@wharton.upenn.edu.
Jeffrey Wurgler
Affiliation:
New York University, Stern School of Business, 44 W. 4th St., Ste. 9-190, New York, NY 10012, and NBER. jwurgler@stern.nyu.edu.

Abstract

Recent research finds that the stocks that mutual fund managers buy outperform the stocks that they sell (e.g., Chen, Jegadeesh, and Wermers (2000)). We study the nature of this stock-picking ability. We construct measures of trading skill based on how the stocks held and traded by fund managers perform at subsequent corporate earnings announcements. This approach increases the power to detect skilled trading and sheds light on its source. We 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. We find that mutual fund trades also forecast earnings surprises. We conclude that mutual fund managers are able to trade profitably in part because they are able to forecast earnings-related fundamentals.

Type
Research Articles
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Abarbanell, J., and Lehavy, R.. “Biased Forecasts or Biased Earnings? The Role of Reported Earnings in Explaining Apparent Bias and Over/Underreaction in Analysts’ Earnings Forecasts.” Journal of Accounting and Economics, 36 (2003), 105146.Google Scholar
Ali, A.; Durtschi, C.; Lev, B.; and Trombley, M.. “Changes in Institutional Ownership and Subsequent Earnings Announcement Abnormal Returns.” Journal of Accounting, Auditing, and Finance, 3 (2004), 221248.Google Scholar
Barras, L.; Scaillet, O.; and Wermers, R.. “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas.” Journal of Finance, 65 (2010), 179216.Google Scholar
Beaver, W. “The Information Content of Annual Earnings Announcements.” Journal of Accounting Research, 6 (1968), 6792.Google Scholar
Bernard, V. L., and Thomas, J. K.. “Post-Earnings-Announcement Drift: Delayed Price Response or Risk Premium?Journal of Accounting Research, 27 (1989), 136.Google Scholar
Brown, N. C.; Wei, K. D.; and Wermers, R.. “Analyst Recommendations, Mutual Fund Herding, and Overreaction in Stock Prices.” Working Paper, University of Southern California (2007).Google Scholar
Brown, S. J., and Goetzmann, W. N.. “Performance Persistence.” Journal of Finance, 50 (1995), 679698.Google Scholar
Carhart, M. M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 5782.Google Scholar
Chari, V. V.; Jagannathan, R.; and Ofer, A. R.. “Seasonalities in Securities Returns: The Case of Earnings Announcements.” Journal of Financial Economics, 21 (1988), 101121.Google Scholar
Chen, H.-L.; Jegadeesh, N.; and Wermers, R.. “The Value of Active Mutual Fund Management: An Examination of the Stockholdings and Trades of Mutual Fund Managers.” Journal of Financial and Quantitative Analysis, 35 (2000), 343368.Google Scholar
Chen, J.; Hong, H.; Huang, M.; and Kubik, J. D.. “Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization.” American Economic Review, 94 (2004), 12761302.Google Scholar
Chevalier, J., and Ellison, G.. “Are Some Mutual Fund Managers Better Than Others? Cross-Sectional Patterns in Behavior and Performance.” Journal of Finance, 54 (1999), 875899.Google Scholar
Christophe, S. E.; Ferri, M. G.; and Angel, J. J.. “Short-Selling Prior to Earnings Announcements.” Journal of Finance, 59 (2004), 18451876.Google Scholar
Cohen, R. B.; Coval, J. D.; and Pastor, L.. “Judging Fund Managers by the Company They Keep.” Journal of Finance, 60 (2005), 10571096.Google Scholar
Daniel, K.; Grinblatt, M.; Titman, S.; and Wermers, R.. “Measuring Mutual Fund Performance with Characteristic-Based Benchmarks.” Journal of Finance, 52 (1997), 10351058.Google Scholar
Elton, E. J.; Gruber, M. J.; and Blake, C. R.. “The Persistence of Risk-Adjusted Mutual Fund Performance.” Journal of Business, 69 (1996), 133157.Google Scholar
Elton, E. J.; Gruber, M. J.; and Blake, C. R.. “Incentive Fees and Mutual Funds.” Journal of Finance, 58 (2003), 779804.Google Scholar
Elton, E. J.; Gruber, M. J.; and Blake, C. R.. “Holdings Data, Security Returns, and the Selection of Superior Mutual Funds.” Journal of Financial and Quantitative Analysis, forthcoming (2010).Google Scholar
Elton, E. J.; Gruber, M. J.; Blake, C. R.; Krasny, Y.; and Ozelge, S. O.. “The Effect of Holdings Data Frequency on Conclusions about Mutual Fund Behavior.” Journal of Banking and Finance, 34 (2010), 912922.Google Scholar
Fama, E. F. “Efficient Capital Markets: A Review of Theory and Empirical Work.” Journal of Finance, 25 (1970), 383417.Google Scholar
Fama, E. F., and French, K. R.. “Size and Book-to-Market Factors in Earnings and Returns.” Journal of Finance, 50 (1995), 131155.Google Scholar
Fama, E. F., and MacBeth, J. D.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607636.Google Scholar
Ferson, W. E., and Schadt, R. W.. “Measuring Fund Strategy and Performance in Changing Economic Conditions.” Journal of Finance, 51 (1996), 425461.Google Scholar
Frazzini, A., and Lamont, O.. “The Earnings Announcement Premium and Trading Volume.” Working Paper, NBER (2007).Google Scholar
Gomes, A.; Gorton, G.; and Madureira, L.. “SEC Regulation Fair Disclosure, Information, and the Cost of Capital.” Journal of Corporate Finance, 13 (2007), 300334.Google Scholar
Grinblatt, M., and Titman, S.. “Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings.” Journal of Business, 62 (1989), 393416.Google Scholar
Grinblatt, M., and Titman, S.. “Performance Measurement Without Benchmarks: An Examination of Mutual Fund Returns.” Journal of Business, 66 (1993), 4768.Google Scholar
Hendricks, D.; Patel, J.; and Zeckhauser, R.. “Hot Hands in Mutual Funds: Short-Run Persistence of Relative Performance, 1974–1988.” Journal of Finance, 48 (1993), 93130.Google Scholar
Ippolito, R. A. “Efficiency with Costly Information: A Study of Mutual Fund Performance, 1965–1984.” Quarterly Journal of Economics, 104 (1989), 123.Google Scholar
Irvine, P.; Lipson, M.; and Puckett, A.. “Tipping.” Review of Financial Studies, 20 (2007), 741768.Google Scholar
Jensen, M. C. “The Performance of Mutual Funds in the Period 1945–1964.” Journal of Finance, 23 (1968), 389416.Google Scholar
Kacperczyk, M., and Seru, A.. “Fund Manager Use of Public Information: New Evidence on Managerial Skills.” Journal of Finance, 62 (2007), 485528.Google Scholar
Kacperczyk, M.; Sialm, C.; and Zheng, L.. “Unobserved Actions of Mutual Funds.” Review of Financial Studies, 21 (2008), 23792416.Google Scholar
Ke, B.; Huddart, S.; and Petroni, K.. “What Insiders Know about Future Earnings and How They Use It: Evidence from Insider Trades.” Journal of Accounting & Economics, 35 (2003), 315346.Google Scholar
La Porta, R.; Lakonishok, J.; Shleifer, A.; and Vishny, R.. “Good News for Value Stocks: Further Evidence on Market Efficiency.” Journal of Finance, 52 (1997), 859874.Google Scholar
Lehman, B., and Modest, D.. “Mutual Fund Performance Evaluation: A Comparison of Benchmarks and Benchmark Comparisons.” Journal of Finance, 42 (1987), 233265.Google Scholar
Seasholes, M. “Re-Examining Information Asymmetries in Emerging Stock Markets.” Working Paper, University of California at Berkeley (2004).Google Scholar
U.S. Securities and Exchange Commission. “Selective Disclosure and Insider Trading.” 17 CFR Parts 240, 243, and 249, Release Nos. 33-7881, 34-43154, IC-24599 (http://www.sec.gov/rules/final/33-7881.htm) (Aug. 10, 2000).Google Scholar
Wermers, R. “Mutual Fund Herding and the Impact on Stock Prices.” Journal of Finance, 54 (1999), 581622.Google Scholar
Wermers, R. “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses.” Journal of Finance, 55 (2000), 16551695.Google Scholar
Yan, X. S., and Zhang, Z.. “Institutional Investors and Equity Returns: Are Short-Term Institutions Better Informed?Review of Financial Studies, 22 (2009), 893924.Google Scholar