FALL 2008 VOL. 9 NO. 2

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What Mutual Funds Can Tell You About Stock Picks

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Is there a way to glean useful information by examining mutual fund holdings? Maybe, but only if you look at what both the best and the worst mutual fund managers are doing.

Russ Wermers, associate professor of finance, developed a statistical model that predicts the future performance of individual stocks based on how heavily they are held or purchased by both successful and unsuccessful fund managers.

Rather than simply looking at the results of winning funds, Wermers and his co-authors examined good, average and bad funds to see what highly skilled—and thus very successful—fund managers were buying in common, and what underperforming fund managers were not buying. The model uses a weighted average alpha to determine the outlook for a stock at the beginning of a given year, consisting of the portfolio weight on a stock multiplied by a manager’s past alpha, summed across all managers who held that stock at the beginning of that month.

“You can’t just consider how many winning funds bought the stock, you have to weight how much of it they purchased, and you also have to put some weight on the skill of the manager,” says Wermers. “We considered the performance of every fund manager and use it as the main factor in the weighting of the outlook for a stock.”

Hedge funds in particular have shown interest in this research because they need an independent source of stock returns beyond what is already known by the masses.

Unfortunately, this information isn’t easy for the average investor to find. Because mutual funds only disclose portfolio holdings information on a quarterly basis, and because the funds have a 60-day grace period to file their holdings with the SEC, investors interested in using this model to predict stock returns are limited by the time lag in receiving information about what mutual fund managers are holding. Mutual fund disclosures are also staggered, so it isn’t easy to obtain the information—for instance, some funds report their holdings in December, while others report in October. Wermers used a multitude of datasets to create the holdings data and returns data used in the study.

For more information about this research, contact rwermers@rhsmith.umd.edu.

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Copyright 2008 Robert H. Smith School of Business