Performance Measurement with Market and Volatility Timing

The investment performance of a portfolio manager who may engage in market timing behavior depends on market level and volatility timing as well as security selection. We develop new holdings-based performance measures that properly adjust for risk, accommodate all three components and avoid strong assumptions about managers’ behavior. Allowing for market level and volatility timing, there is no significant evidence of investment ability for broad groups of mutual funds or for funds are sorted by expense ratios, return gap, active share, turnover or other parameters. The performance before costs is estimated to be precisely close to zero in most cases. However, sorting by factor model R-squares confirms results in Amihud and Goyenko (2012), where the low R-square funds have better performance, and there is some evidence that performance may be related to volatility timing behavior and to the level of market sentiment. * Ferson is the Ivadelle and Theodore Johnson Chair of Banking and Finance and a Research Associate of the National Bureau of Economic Research, Marshall School of Business, University of Southern California, 3670 Trousdale Parkway Suite 308, Los Angeles, CA. 90089-0804, ph. (213) 740-5615, [email protected], wwwrcf.usc.edu/~ferson/. Mo is a Ph.D student in Finance, Marshall School of Business, University of Southern California, [email protected]. We are grateful to Fabio Moneta for help with some data, to participants at the 2012 Northern Finance meetings, the 2012 Sonoran Finance Conference, the 2012 Alberta Frontiers in Finance conference, the 2012 conference on Financial Economics, Accounting and Management and workshops at the University of Southern California and Texas A+M for helpful discussions, and to Oliver Boguth, Yong Chen and Yakov Amihud for comments.