Distribution of Individual Stock Performances in a Mutual Fund and the Fund Manager’s Stock Picking Ability

We find that the performance distribution of the individual stocks inside a mutual fund can toss out additional information about the fund manager’s stock picking ability. When a mutual fund contains mostly mediocre-performing stocks but one super-performer, it is likely that the overall fund performance, albeit good, would be due to luck. On the other hand, a fund that has a larger number of above-average performing stocks may have a good fund performance due to its manager’s true ability. With this intuition in mind, we develop a measure of fund manager ability from the distribution of the individual stock performances inside the fund. Our measure predicts fund performances for up to two years. An investment strategy based on our measure can generate an extra 9% annual return. Our measure has the strongest explanatory power for currently well-performing mutual funds, suggesting that it would be very useful to tell whether the current good performance is due to luck or true ability of the fund manager.