Momentum in Mutual Fund Returns

Fundamental reason

Simple trading strategy

Out-of-sample strategy's implementation/validation in QuantConnect's framework(chart, statistics & code)

Source paper

Sapp: The 52-Week High, Momentum, and Predicting Mutual Fund Returns

Abstract: The 52-week high share price has been shown by George and Hwang (2004) to carry significant predictive ability for individual stock returns, dominating other common momentum-based trading strategies. This study examines the performance of trading strategies for mutual funds based on (1) an analogous 1-year high measure for the net asset value of fund shares, (2) prior extreme returns and (3) fund sensitivity to stock return momentum. All three measures have significant, independent, predictive ability for fund returns. Further, each produces a distinctive pattern in momentum profits, whether measured in raw or risk-adjusted returns, with profits from momentum loading being the least transitory. Nearness to the 1-year high and recent extreme returns are significant predictors of fund monthly cash flows, whereas fund momentum loading is not.

Other papers

• Sapp, Tiwari: Stock Return Momentum and Investor Fund Choice

  Abstract: Recent research by Gruber (1996) and Zheng (1999) finds that investors are able to predict mutual fund performance and invest accordingly. This phenomenon has been dubbed the “smart money” effect. We show that the smart money effect is explained by stock return momentum at the one year horizon. This finding then begs the question of what exactly investors seem to be chasing —momentum styles or recent large returns? Further evidence suggests investors do not select funds based on a momentum investing style, but rather simply chase funds that were recent winners. Thus, our finding that a common factor in stock returns explains the smart money effect offers no affirmation of investor fund selection ability. We also investigate the profitability of a pure momentum style strategy that invests solely in no-load equity mutual funds. We show that a quarterly fund selection strategy of investing in the top decile portfolio of no-load funds ranked by their historical momentum exposure yields an annualized 3-factor alpha of 3.72% over the period 1973-2000.

• Friesen, Nguyen: The Economic Impact of Mutual Fund Investor Behaviors

  Abstract: This study analyzes how the determinants of mutual fund investor cash flows have changed over time, and the associated impact on investor returns. Using data from 1992-2016 we find that investor return-chasing behavior essentially disappeared starting in 2011. Investor flows have become more sensitive to expenses, past risk and alpha. Investors are paying more attention to fund characteristics that matter (e.g. risk, alpha and expenses), and less attention to characteristics that don’t (e.g. past returns). Nevertheless, the average investor dollar-weighted return is about 1.2% below the average buy-and-hold return in their underlying mutual fund nearly every year in our sample, suggesting consistently poor timing ability over the entire period. We decompose the economic impact of investor behaviors on investor returns and find that investors’ focus on alpha is actually more detrimental than their previous focus on past returns. Investors do benefit from choosing high-alpha funds (smart money), but poorly time their cash flows by investing in those funds after periods with the highest realized alphas (dumb money). The dumb money effect dominates the smart money effect for the simple reason that at the fund level, past alphas are strongly and negatively correlated with future alphas. Although past alphas are positively correlated to future alphas in the pooled cross-section of mutual fund data, this result does not hold at the individual fund level, which is the level where most mutual fund customers invest. Overall, our results suggest that mutual fund investors know that alpha is important, but have not yet learned how to effectively integrate this knowledge into their investment decisions.

• Cuthbertson, Keith and Nitzsche, Dirk and O'Sullivan, Niall: UK Mutual Funds: Performance Persistence and Portfolio Size

  Abstract: We re-examine performance persistence amongst UK mutual funds. Specifically, we investigate performance persistence among small portfolios of past high-performing funds. In contrast to the more common analysis of decile portfolios of funds, we focus on persistence in the more extreme positive tail of the cross-section of fund performance. This paper contributes to the smaller literature on UK rather than US mutual fund performance. We investigate fund persistence based on practitioner index models as well as academic factor models, focusing on small portfolios of funds using inference based on nonparametric persistence test statistics as well as conventional t-tests. We provide strong evidence of positive persistence among small-size portfolios of (past) high performing funds that is robust to alternative formation and holding periods and alternative performance models. We also document some sensitivity in inferences on positive persistence when using nonparametric versus conventional tests.