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

Part of:JFQA William F. Sharpe Best Paper Award Winner

Published online by Cambridge University Press:  02 August 2010

Malcolm Baker,
Lubomir Litov,
Jessica A. Wachter and
Jeffrey Wurgler
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.
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Abstract

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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.

Information

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 5 , October 2010, pp. 1111 - 1131
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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