Separating Mutual Fund Alpha into Stock Selection and Weighting
Summary
The article explains a method for separating a mutual fund’s total alpha into selection alpha and weighting alpha. Selection alpha is estimated by replacing reported portfolio weights with market-cap weights, isolating the contribution of choosing stocks; weighting alpha is the difference between total and selection alpha. The study examines U.S. actively managed domestic equity funds using historical holdings and returns, and compares the two components with conventional measures such as concentration and active share.
The reported average selection contribution is slightly negative, while weighting contributes positively, and weighting alpha remains predictive for as long as a year compared with roughly one month for selection alpha. Funds scoring highly on both dimensions also show stronger subsequent performance in the reported portfolio sorts. The study finds that these measures add information beyond several measures of portfolio activeness and concentration. Its estimates omit fees, transaction costs, non-U.S. holdings, and within-quarter turnover, and the evidence comes from historical U.S. fund data; it describes manager skill rather than realized investor returns.
Key ideas
- Total fund alpha can be decomposed into stock selection alpha and weighting alpha.
- Selection alpha uses market-cap weights to reduce the effect of portfolio allocation decisions.
- In the study, weighting alpha contributed more on average and persisted longer than selection alpha.
- Funds with strong selection and weighting measures had better subsequent results in the reported sorts.
- The analysis uses historical U.S. holdings and excludes costs and some portfolio activity, limiting investor-level interpretation.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.