We found a negative relation between mutual funds’ past R2 and their abnormal performance, as did Amihud and Goyenko (2013), who proposed measuring active management of mutual funds by 1−R2. The interpretation of this relationship would be that active management pays. However the same evidence is uncovered for artificial investments, due only to the behavior of the types of stocks they are holding. Therefore, we introduce a new factor, ImS (idiosyncratic minus systematic), defined as the difference between the stocks’ returns with lower and higher past R2 which captures this behavior. After adjusting for this factor, the initial evidence vanishes and abnormal performance associated with past R2 diminishes, even taking negative values for mutual funds.
Critical Finance Review, Volume 12, Issue 1-4 Special Issue: Volatility and Higher Moments: Articles Overview
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