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.