Limitations of HM and TM Models for Fund Timing Evaluation
Summary
This report examines shortcomings in the Henriksson–Merton (HM) and Treynor–Mazuy (TM) models for assessing fund managers’ market and style timing. TM represents beta adjustment as a gradual quadratic pattern, while HM assumes a two-state exposure shift; both may differ from how managers actually change positions. Their full-window regressions can also mix observations from different market regimes, and their focus on contemporaneous moves may miss positioning ahead of market changes.
As a supplement, the report proposes regressing rolling fund beta exposures on contemporaneous market or style returns and using coefficient significance to identify timing. Its tests classify a larger share of funds as capable of timing than the classic models do, with reported shares of 35.2% for market timing and about 45.7% for size and value style timing. Cross-period checks show some stability. The report recommends combining both quantitative approaches with qualitative analysis; its findings remain subject to market, policy, and model-specification risks.
Key ideas
- The HM model assumes discrete exposure shifts, while the TM model assumes a quadratic pattern of beta adjustment.
- Full-window regressions can let observations from different market regimes distort beta estimates.
- Contemporaneous timing tests may fail to recognize managers who position ahead of market moves.
- A proposed alternative regresses rolling beta exposure on market or style returns and assesses coefficient significance.
- The report recommends combining classic and alternative models with qualitative judgment.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.