Mutual Fund Alpha and Coskewness: Sources and Trade-Offs

Summary

This research review examines whether actively managed U.S. equity funds can generate CAPM alpha without weakening the coskewness of their returns with the market. It explains why investors who value positive skew may care about coskewness alongside conventional risk-adjusted performance. The central finding is a negative cross-sectional association: funds with higher alpha tend to have less favorable coskewness, with stock selection appearing to drive much of the trade-off even after style controls.

The analysis attributes fund coskewness to market timing, cash management, derivative use, and security selection. Successful market timing is associated with more favorable coskewness, while delayed investment of inflows into illiquid holdings and some option strategies can produce unfavorable effects. The study uses daily fund returns, holdings, and reported activity measures, and finds that fund flows respond to coskewness as well as alpha, especially among funds with more institutional ownership. These results come from historical U.S. fund data and do not establish that the same relationships hold in other markets or periods.

Key ideas

• Higher-alpha funds tend to have less favorable market coskewness in the observed fund cross-section.
• Market timing, liquidity management, derivative use, and security selection can each affect fund coskewness.
• The negative alpha-coskewness relationship persists after controlling for investment style.
• Fund flows respond to coskewness, with greater sensitivity among funds with more institutional ownership.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.