Momentum Investment Strategies of Mutual Funds, Performance Persistence, and Survivorship Bias

We show that the persistent use of momentum investment strategies by mutual funds has important implications for the performance persistence and survivorship bias controversies. Using mutual fund portfolio holdings from a database free of survivorship bias, we ̄nd that the best performing funds during one year are the best performers during the following year, with the exception of 1981, 1983, 1988, and 1989. This pattern corresponds exactly to the pattern exhibited by the momentum e®ect in stock returns, ̄rst documented by Jegadeesh and Titman (1993) and recently studied by Chan, Jegadeesh, and Lakonishok (1996). Our evidence points not only to the momentum e®ect in stock returns, but to the persistent, active use of momentum strategies by mutual funds as the reasons for performance persistence. Moreover, essentially no persistence remains after controlling for the one-year momentum e®ect in stock returns. We also explain why most recent studies have found that survivorship bias is a relatively small concern. Funds that were the best performers during one year are the worst performers during the following year whenever the momentum e®ect in stock returns is absent, and these funds tend to disappear with a frequency not appreciably lower than that of consistently poor performers. Therefore, the pool of non-surviving funds is more representative of the cross-section of all funds than previously thought. Speci ̄cally, we ̄nd a di®erence of only 20 basis points per year in risk-adjusted pre-expense returns between the average fund and the average surviving fund.