do strongfundsstrong make more when they trade more luboˇs p#180;astor.pdfVIP

Do Funds Make More When They Trade More? ˇ Luboˇs P´astor Robert F. Stambaugh Lucian A. Taylor * November 14, 2014 Abstract We find that active mutual funds perform better after trading more. This time-series relation between a fund’s turnover and its subsequent benchmark- adjusted return is especially strong for small, high-fee funds. These results are consistent with high-fee funds having greater skill to identify time-varying profit opportunities and with small funds being more able to exploit those opportuni- ties. In addition to this novel evidence of managerial skill and fund-level decreas- ing returns to scale, we find evidence of industry-level decreasing returns: The positive turnover-performance relation weakens when funds act more in concert. We also identify a common component of fund trading that is correlated with mispricing proxies and helps predict fund returns. * P´astor is at the University of Chicago Booth School of Business. Stambaugh and Taylor are at the Wharton School of the University of Pennsylvania. Email: lubos.pastor@, stam- baugh@, luket@. We are grateful for comments from Gene Fama, Todd Gormley, Christian Hansen, Marcin Kacperczyk, David Musto, Sergei Sarkissian, and the audiences at Aalto University, BI Oslo, Cass, Cheung Kong, Copenhagen, Houston, Mannheim, McGill, NBIM, NHH Bergen, Tsinghua PBCSF, Tsinghua SEM, and Wharton. We are also grateful to Yeguang Chi and Gerardo Manzo for superb research assistance. Electronic copy available at