Do Mutual Funds Profit from Accruals and NOA Anomalies?

In this study, we examine three issues related to the accrual and the net operating assets (NOA) anomalies. First, whether mutual funds trade on these anomalies. Second whether they are able to generate profits, net of transaction costs. Third, the reasons why such profits are not completely exploited. Prior studies provide evidence on the first issue by examining the trading behavior of institutional investors in the context of the accruals anomaly. However, there is little direct evidence on the second and the third issues. The primary reason, that prior studies do not address these issues is because they use data from 13F filings. These data provide information on institutional holdings but do not provide information on their fund returns and fund flows, which are important for addressing these issues. We obtain data on mutual fund portfolio holdings from the 13F filings and on mutual fund returns and fund flows from CRSP. We combine these data and provide the following results. First, mutual funds actively follow both the accrual and the NOA anomalies. Second, funds that follow these anomalies aggressively exhibit significant profits, net of actual transaction costs and fund expenses, suggesting that for the accrual and NOA anomalies transaction costs cannot completely explain the magnitude and persistence of these anomalies. Finally, funds that more aggressively follow the anomalies have higher volatility in fund returns and fund flows, suggesting that residual profits are not completely arbitraged away because of inelastic supply of arbitrage capital induced by arbitrage risks (Shleifer and Vishny 1997). Corresponding author: Ashiq Ali School of Management, SM41 The University of Texas at Dallas Richardson, TX 75083-0688 e-mail: [email protected] Phone: 972-883-6360 ________________________ *Department of Accounting and Information System, University of Texas, Dallas. **College of Business Administration, University of Rhode Island. ***Department of Finance, University of Arizona.