Mutual Fund Risk Shifting and Its Effects on Future Performance
Summary
The study measures a fund’s risk shifting by comparing the volatility implied by its latest disclosed holdings with the fund’s realized volatility over the same rolling period. Using quarterly holdings and return data for actively managed US domestic equity funds from 1980 to 2009, it groups funds by this measure and estimates risk-adjusted performance with several factor models, including Carhart. Funds that raised risk tended to have worse subsequent abnormal returns than funds with relatively stable risk; lowering risk showed no comparable performance penalty.
The analysis attributes much of the negative association to rising idiosyncratic risk and benchmark tracking-error volatility, while changes in cash holdings and systematic risk matter less. The pattern persists across alternative adjustments and controls, though it is historical evidence from a specific market and sample, not proof of causality or a forecast for current funds. The authors also find that stronger active management does not imply greater risk shifting or better manager skill.
Key ideas
- Risk shifting is measured as the gap between holdings-implied and realized volatility over a rolling period.
- Funds that increased risk showed weaker risk-adjusted future performance than stable-risk funds in the historical sample.
- Higher idiosyncratic risk and tracking-error volatility accounted for more of the negative association than cash or systematic-risk changes.
- Risk shifting’s costs were larger for some funds, including those with weaker past returns and higher fees.
- Greater active management did not reliably indicate more risk shifting or better manager ability.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.