Does herding behavior reveal skill? An analysis of mutual fund performance

This paper …nds that fund herding, de…ned as the tendency of a mutual fund to follow past aggregate institutional trades, is an important predictor of mutual fund performance. Examining actively managed U.S. equity mutual funds over the period 1990-2009, we …nd that funds with a higher herding tendency achieve lower future returns. The performance gap between herding and antiherding funds is persistent over various horizons and is more pronounced in periods of greater investment opportunities in the active management industry. We show that fund herding is negatively correlated with recently developed measures of mutual fund skill and provides distinct information for the predictability of mutual fund performance. Overall, our results suggest that fund herding reveals information about the cross-sectional distribution of skill in the mutual fund industry. Keywords: Mutual funds, performance, herding, imitation, alpha. J.E.L. codes: G11, G20, G23. Jiang: Rotterdam School of Management, Erasmus University, Rotterdam, the Netherlands. Email: [email protected]. Verardo: Department of Finance, London School of Economics, London, United Kingdom. Email: [email protected]. We thank Amil Dasgupta, Dong Lou, Christopher Polk, ×ukasz Pomorski, René Stulz, Sheridan Titman, Dimitri Vayanos, Paul Woolley, Kathy Yuan, and seminar participants at Erasmus University Rotterdam, London School of Economics, University of Amsterdam, Cattolica University of Milan, IESE Barcelona, University of Nottingham, University of Vienna, the 2011 SEI Summer Conference at IDC, and the 2012 WFA meetings for helpful comments and suggestions. Verardo gratefully acknowledges …nancial support from the Paul Woolley Centre at the LSE.