Patient Capital - A Study On The Outperformance Of Infrequent Traders

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Electronic copy available at: http://ssrn.com/abstract=2498743 Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently Martijn Cremers Ankur Pareek University of Notre Dame Rutgers Business School First draft: December 2013 This draft: September 2014 This paper documents that among high Active Share portfolios – whose holdings differ substantially from the holdings of their benchmark – only those with patient investment strategies (i.e., with long stock holding durations of at least 2 years) outperform their benchmarks on average. Funds trading frequently generally underperform, regardless of Active Share. Among funds that infrequently trade, it is crucial to separate closet index funds – whose holdings largely overlap with the benchmark – from truly active funds. The average outperformance of the most patient and distinct portfolios equals 2.30% per year – net of costs – for retail mutual funds. Stocks held by patient and active institutions in general outperform by 2.22% per year and by hedge funds in particular by 3.64% per year, both gross of costs. JEL Classifications: G12, G24 Contact info: Martijn Cremers: 264 Mendoza College of Business, University of Notre Dame, Notre Dame, IN 46556, Phone: 574‐631‐4476, Email: [email protected]. Ankur Pareek: Rutgers Business School, 1 Washington Park, Newark, NJ 07102, Phone: 973‐353‐1646, Email: [email protected]. We thank the Q‐Group for financial support.

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Patient Capital - A Study On The Outperformance of Infrequent Traders

Transcript of Patient Capital - A Study On The Outperformance Of Infrequent Traders

  • Electronic copy available at: http://ssrn.com/abstract=2498743

    PatientCapitalOutperformance:TheInvestmentSkillofHighActiveShareManagers

    WhoTradeInfrequently

    MartijnCremersAnkurPareekUniversityofNotreDameRutgersBusinessSchool

    Firstdraft:December2013Thisdraft:September2014

    This paper documents that among highActive Share portfolios whose holdings differ substantiallyfrom theholdingsof theirbenchmarkonly thosewithpatient investment strategies (i.e.,with longstock holding durations of at least 2 years) outperform their benchmarks on average. Funds tradingfrequentlygenerallyunderperform,regardlessofActiveShare.Amongfundsthatinfrequentlytrade,itiscrucialtoseparateclosetindexfundswhoseholdingslargelyoverlapwiththebenchmarkfromtrulyactivefunds.Theaverageoutperformanceofthemostpatientanddistinctportfoliosequals2.30%peryearnetofcosts forretailmutual funds. Stocksheldbypatientandactive institutions ingeneraloutperformby2.22%peryearandbyhedgefundsinparticularby3.64%peryear,bothgrossofcosts.

    JELClassifications:G12,G24Contact info:Martijn Cremers: 264 Mendoza College of Business, University of Notre Dame,Notre Dame, IN46556,Phone:5746314476, Email:[email protected]:RutgersBusiness School,1WashingtonPark,Newark,NJ07102,Phone:9733531646,Email:ankur.pareek@business.rutgers.edu.WethanktheQGroupforfinancialsupport.

  • Electronic copy available at: http://ssrn.com/abstract=2498743

    Introduction

    Which, if any, activelymanaged portfolios can outperform passive benchmarks? Theprevious literature has documented that, on average, the longterm net performance ofactivelymanagedmutualfundsissimilartotheperformanceoftheirbenchmark(withactivelymanaged funds generally underperforming their benchmarks but without strong statisticalsignificance on average).However, some papers argue that some smaller subset of activelymanagedmutual funds that is identifiableexante isable toconsistentlyoutperform,onaverage,overfairlylongperiodsoftime(see,e.g.,Cohen,CovalandPastor,2005;Kacperczyk,Sialm,andZheng,2005;Mamaysky,SpiegelandZhang,2008;KacperczykandSeru,2007;andCremersandPetajisto,2009).Anecessaryconditionfor longtermoutperformance isthattheactivelymanagedportfolioissubstantiallydifferentthanthebenchmark,whichisconsideredinKacperczyk,Sialm,andZheng (2005)andCremersandPetajisto (2009).Both findthatmutualfundswhoseholdingsaremoredifferent fromtheirbenchmarks,onaverageand inthe longterm,outperformtheirbenchmarksnetoffees.Kacperczyk,Sialm,andZheng(2005)consideronly industrybetsusing the IndustryConcentration Index,andCremersandPetajisto (2009)consider all stock positions using Active Share, i.e., the proportion of fund holdings that isdifferentfromthebenchmark.

    FundswithhighActiveSharehave littleoverlapwiththebenchmarkholdingsandthusaretrulyactivelymanaged.MutualfundswithlowActiveShareshavesimilarholdingsastheirbenchmark.CremersandPetajisto(2009)foundthatsuch closet indexfundshavetendedtosignificantlyunderperformtheirbenchmarks(afterfees)inthefuturebyabout1%peryear.Atthe same time, theyalso found that fundswithabove90%ActiveShareoutperformed theirbenchmarksbyabout1%ayear,afterfeesweretakenout.Cremers,Ferreira,MatosandStarks(2014)analyzealargeinternationalsampleofmutualfundsdomiciledin32differentcountries,andlikewisefindthathighActiveSharefundsonaverageoutperformtheirbenchmarksinthefuturewhilelowActiveSharefundsunderperform.

    Inthispaper,weexaminethesourceofthisapparentinvestmentskillbythemostactivemanagers, focusingonhow fundoutperformance isrelatedto fundholdingdurationsorhow

  • frequentlythefundmanagertrades.Exante, it isnotclearwhetherfundswouldgenerallybemore successful throughholding stocks for longperiodsor through frequently changing theportfolio.Ontheonehand,ifmarketsarefairlyinformationefficient,thenanyinformationthatafundmanageristradingonwillbeincorporatedinthemarketquickly.Asaresult,managersmayneedtofrequentlytradeinordertobenefitfromtheirtemporarysuperiorinformation.

    Ontheotherhand, fundmanagersmaybeabletospotmarketmispricingthat isonlyreversedoverlongerperiods,requiringstrongmanagerconvictionandinvestorpatience.Inthiscase,managerswouldonlyoutperformbyholdingstocksover longerperiods.Thisrequiresastrong conviction on the part of themanager, as stock pricesmay initiallymove adverselybeforereversinganymispricing.Similarly, itrequiresthat investorsare fairlypatient ingivingthe manager time to see the strategy through, rather than evaluate the performance arerelatively brief periods of time. An investment approach with long holding durations maybenefit from opportunities to buy relatively illiquid or deepvalue stocks on the cheap (seeAmihud, Mendelson and Pedersen, 2005), at the detriment of potentially allowingoverconfidentfundmanagerstopersistinwrongconvictions.

    Finally,itseemspossibleexantethatbothshorttermandlongtermopportunitiesmaycoexist, and that differentmanagerswith different skills set, convictions and opportunitiesfocusonwhere they think theyhave the strongestadvantage.Whether somemanagersareabletobenefitfromtheirshorttermtradesthatcouldpotentiallyexploittemporarymispricingor shortlived information advantages, and whether other managers can exploit longtermundervaluationorbenefit froman illiquiditypremiumarethusseparatebutrelatedempiricalquestions.

    Theextantempiricalliteraturehasnotdocumentedastronglinkbetweenfundholdingdurations(ortradingfrequency)andsubsequentfundperformance.Wearguethatthereasonforthis,andtheexplanationthatweareabletofindastrongassociation,isthatwedistinguishbetween truly actively managed funds and those whose holdings are fairly similar to thebenchmarks,i.e.,thatwedistinguishbetweenfundswithlowversushighActiveShare.Amongfundswith longholdingdurations,onewillnaturally findboth (closet) index funds and very

  • activemanagerswhopatientlywait for themarket to reward their longtermbetsagainst it.Similarly,amongfundswithshortaverageholdingperiods,onemayexpecttofindfundswhichareaggressivelytradingwiththebulkoftheirportfolioaswellasfundswhichholdsubstantialpositions overlapping the benchmark butwho churn or very frequently turn over a smallerfractionoftheirportfolio.

    Our basic setup is straightforward. We consider both a large sample of activelymanaged allequity U.S. retail mutual funds from the CRSP Survivorshipfree mutual funddatabase,andthesampleofallaggregatedinstitutionalinvestorportfoliosfromtheirquarterly13F statements. For each sample, we perform 5x5 double sorts of portfolios into holdingduration(orturnover)quintilesandActiveSharequintiles,andthencomparetheperformancealongbothdimensions.Foroursampleofmutual funds,weconsiderthe futureperformanceover the 19year period from 1995 2013, and evaluate the performance of both the netreturns to investorsafterall trading costsand fees (except frontand rearend loads)andoftheir holdingsbased gross returns. For our sample of aggregate institutional portfolios,weanalyzethe longerperiodof19862013,butonlyconsiderholdingsbased grossreturnsaswedonotobservetheiractualafterfeenetreturns.WeevaluateperformanceofthenetaftercosttradingreturnsafterbenchmarkadjustingasmotivatedbyCremers,PetajistoandZitzewitz(2013) generally using the mutual funds selfdeclared benchmarks and evaluate theperformanceofthegrossholdingsbasedreturnsaftercontrollingforsizeandbooktomarketcharacteristicsaccordingtoDaniel,Grinblatt,TitmanandWermers(1997).

    Weemploy threeproxies forhow long fundshold stocks in theirportfolios.The firstproxy istheFundDurationasrecently introduced inCremersandPareek(2013)andCremers,PareekandSautner(2013)attheportfoliolevel.FundDurationmeasurestheweightedaveragelengthoftimethatthefundhasheld$1ofequities intheportfoliooverthe last5years.Thesecondproxyistheholdingsbasedfundturnover,whichwecalculateourselvesforthemutualfund and institutionalquarterlyportfolios as inGaspar,Massa, andMatos (2005). The thirdproxyisonlyavailableforthemutualfundsample,andistheselfdeclaredFundTurnoverRatio,

  • i.e., the ratio of all sales / buys in the calendar year over the number of fund sharesoutstanding.

    ThemedianActiveSharei.e.,theproportionofportfolioweightsthatdoesnotoverlapwithbenchmarkweightsofmutualfundsequals79%inoursample,withahighof86%atthebeginningofoursample in1994anda lowof73% in2002.Funds inthebottomActiveSharequintilegenerallyhaveanActiveSharebelow60%and can thusbe considered closet indexfunds.FundsinthetopActiveSharequintileportfoliohaveanActiveShareofatleast90%,andthushaveholdingsthatarequitedistinctfromtheirbenchmarks.Themedianholdingdurationisourmutualfundsampleequals14months,whilemutualfundsinthebottomFundDurationquintile portfolio hold stocks generally for less than 7 months and those in the top FundDurationquintileformorethan24months.ThecrosssectionofFundDurationshasbeenfairlystableovertime.1

    Ourevidenceshowsthat,amonghighActiveSharefunds,patientlymanagedportfolioshave been most likely to outperform. Patient funds are those which trade relativelyinfrequently, i.e., fundswith longholdingdurationsor lowportfolio turnover.The longtermoutperformance of the highActive Share andpatient funds is economically remarkable. Forexample, letsconsidertheequallyweightedportfolioofmutualfundswhereboththeActiveShareandtheFundDurationareinthetopquintile.Thesepatientfundswereabletobeattheirbenchmarksinthe12monthsfollowingportfolioconstruction,aftercosts,by1.92%peryear(tstatof2.08).Adjustingthebenchmarkadjustednetreturnsforexposuretothestandardfivefactors(market,size,booktomarket,momentumandliquidity)increasestheoutperformanceto 2.30% per year (tstat of 3.14). Compounding this over the 19year period (19952013)producesacumulativeoutperformanceof54%.

    1ThemedianActiveShareforourinstitutioninvestorsampleissimilartothemutualfundsampleat73%,HedgefundsarethemostactivegroupofinstitutionswithamedianActiveShareof84%andpublicpensionfundsaretheleastactivewithamedianActiveShareof21%.HedgeFundsarealsothemostshorttermwithamedianFundDurationof0.75 yearsandpublicpension fundsare themost longtermwithamedian FundDurationof2.41years.

  • Similarly, the stocks held by high Active Share and patient institutional portfoliosoutperformby2.22%peryearonaverage(tstatisticof4.10),whichcompoundedoverthe27year period (19862012) accumulates to an outperformance of 80%. Finally, among patientinstitutions with high Active Share we find that hedge funds have particularly strongoutperformance,with an annualized alpha of 3.64% (tstatistic of 3.04),which compoundedover the19yearperiod (19942012)aggregates to97%outperformance. Incontrast, there islittleevidencethattheholdingsofhedgefundsgenerallyoutperform(seealsoGriffinandXu,2009).ThisagainhighlightstheimportanceofdistinguishingbetweenhighandlowActiveSharehedge funds, and among highActive Share hedge funds between shortterm and longterminvestors.2

    We findnoevidence thateven themostactive (i.e.,highActiveShare)mutual fundswithshortdurationsorfrequenttradingwereabletooutperformtheirbenchmarksonaverage.Rather, we find that frequently trading mutual funds systematically underperformed theirbenchmarks, regardless of how different their holdings are relative to their benchmark. Forexample, the equallyweighted portfolio ofmutual fundswith short FundDuration and lowActiveShare(both inthefirstquintile)underperformedconsiderablywithanabnormalreturnof2.46%peryear(tstatof5.52).ThemutualfundportfoliowithshortFundDurationandhighActiveSharefundssimilarlyunderperformedwithanannualabnormalreturnof1.94%(tstatof 2.45). This suggests that only active bets that were also patient (or longerterm) wererewarded inthemarkets,whileweactiveshorttermmutualfundbetswereonaveragequiteunprofitable.3

    2Our resultsare robust to removing fromoursample thegroupof institutionswhoseportfoliosaredominated(withportfolioweightsabove90%)byonesinglestockthatisheldlongterm.ExamplesaretheinstitutionalfilingsofAmericanExpressCompany,variousESOPsholdingsalmostexclusively thestockof thesponsoringcompany,andfoundationsandendowmentswhose13Ffilingsalmostexclusivelycontainasinglestock(suchastheGannettFoundation,theGeneralElectricFoundation,theWilliam&FloraHewlettFoundation,theRobertWoodJohnsonFoundation,theKresgeFoundation,theLillyEndowmentandtheUniversityofDelaware).3Forour institutional sample, the stocksheldby institutions (andhedge funds)with shortFundDurationshadinsignificant alphas andDGTWadjusted returns.Naturally, that does notmean that these institutions did notoutperformorunderperform,asweonlyobservetheirholdingsandnot,forexample,theirwithinquarterroundtrip trades. Themore often an institution trades, the less informative about investment skill the quarterendholdingswillbe.Therefore,wecannotconcludeanythingabouttheinvestmentskilloftheshortterminstitutions

  • The lack of profitability from active shortterm bets is consistentwith the literaturearguing that shortterm trading by institutional investors is associated with greater pricingefficiency (see,e.g.,Collins,Gong, andHribar,2003;Ke andRamalingegowda,2005;Bartov,RadhakrishnanandKrinsky,2000;andBoehmerandKelley,2009).This literatureargues thatthestocksinwhichshortterminstitutionstradetendtobeefficientlypricedandthusunlikelyto allow profitable shortterm trades.On the other hand, Puckett and Yan (2011) find thatinstitutionalroundtriptradeswithinthequarteraregenerallyprofitable,estimatingthattheseshortterm trades add about 26 basis points per year on average. However, Chakrabarty,MoultonandTrzcinka (2014),examiningthesamedataasPuckettandYan (2011),documentthat shortterm roundtrip trades ingeneral (i.e.,not limited toonly those thatarewithinacalendarquarter)arenotprofitable.Onecontributionofourpaper istoconsiderthisdebatewithinthecontextofthelargeliteratureonmutualfundperformance.

    Holding stocks for a relatively long period is in itself on average not associatedwithgreater investment skill. Rather, Active Share matters most among funds with long FundDurations,while among fundswith short FundDurations the difference in the performancebetweencloset indexfundsandhighActiveSharefunds iseconomicallysmallandstatisticallyinsignificant. For example and using equalweighting, the longshort portfolio that is long infundswithhighActiveShareand longFundDurationandshorts fundswith lowActiveShareand long Fund Duration has an annualized alpha of 3.47% (tstatistic of 4.78), while theanalogouslongshorthighlowActiveShareportfolioamongshortFundDurationportfolioshasanalphaof0.44%peryear(tstatisticof0.57).

    We try to explain the managerial skill of the high Active Share and patient fundmanagersbyexaminingtheirexposureto7factorssuggestedbytheexistingliterature:market,size, booktomarket, momentum, systematic liquidity, low versus high beta and earningsquality. For the last two factors,we use the recently proposed Betting against Beta (BaB)factor (see Frazzini and Pedersen, 2013) and Qualityminus Junk (QmJ) factor (seeAsness,Frazzini,andPedersen,2013), respectively.We find that these latter two factorscanexplainper se, and only observe that their quarterend holdings do not exhibit any investment skill. See further ourdiscussioninthenextparagraph.

  • mostof theoutperformanceof thepatientandhighActiveSharemanagersofmutual funds,butonlya fairly small fractionof thegrossoutperformanceof the stocks in the institutionalportfolioswithhighActiveShareandlongFundDuration.Specifically,theclearmajorityoftheoutperformanceof thepatientandactivemutual fundmanagers seemsdue to theirpickingsafe (low beta), value (high booktomarket) and quality (profitable, growing, less valuationuncertainty,higherpayout)stocks,and thenstickingwith theirconvictionsandholdingon tothoseover relatively longperiods.Our results thus suggest thatWarrenBuffetts investmentskill (see Frazzini, Kabiller and Pedersen, 2013) seems generally shared by mutual fundmanagersinthetopActiveShareandFundDurationquintiles.

    In conclusion, our results indicate that Active Share and Fund Duration are bothimportantdimensionsofactivemanagement thatstrongly interact inpredicting theabilityoffundmanagers tobeat theirbenchmarksand inpredicting theoutperformanceof thestocksheldininstitutionalportfolios.Whilelongtermfundmanagersingeneralwereunabletobeattheirbenchmark,onlyhighActiveSharemanagerspursuingpatientstrategiesweresuccessful.Thisunderscoresthe importanceofdistinguishingbetweentrulyactivefundsandthosefundswhose holdings have significant overlapping holdings with their benchmarks. Similarly, ourresults highlight the importance of distinguishing among the truly active funds betweenmanagers pursuing shortterm mispricing (generally unsuccessfully in our sample) versusmanagerswho stickwith the courage of their convictions and patiently (and in our samplesuccessfully)followabuyandholdstrategywithadistinctportfolio.

    2.Data,methodologyanddescriptivestatistics

    2.1Dataandmethodology

    Weconsidertwodifferentsamplesoffunds.ThefirstsampleincludesactivelymanagedallequityU.S.retailmutualfundsfromtheCRSPSurvivorshipfreemutualfunddatabase,andthe second sample all aggregate institutional investor portfolios from their quarterly 13Fstatements.

  • FromtheCRSPSurvivorshipfreemutualfunddatabasethatincludesdead,mergedanddelistedfunds,weusethenetfundreturns(afterfees,tradingcosts,otherexpensesincludingbrokerage commissions, but before taking out any rear or frontend loads), total net assets(TNA)undermanagement,theannualturnoverratioandtheannualexpenseratio.For fundswithmultipleshareclasses,wesumthetotalnetassetsineachshareclasstoarriveatthetotalnet assets in the fund. For theexpense ratio, turnover, and thepercentageof stocks in theportfolio,weaveragetheseacrossshareclassesweightingbythevalueoftheassets.

    We focusonactivelymanaged funds investingalmostexclusively inU.S.equities.Asaresult,weusethefollowingsampleselectioncriteria,whicharestandard inthe literatureandwere also used in Cremers and Petajisto (2009). First, we require the Lipper Prospectusobjectivecode, theStrategic Insightobjectivecode,and theWeisenbergerObjective code inCRSPtoindicatethatthefirmispursuinganactiveU.S.equitystrategythatisnotfocusingonone ormore particular industries or sectors.4 Second,we exclude index funds and ETFs asindicated by CRSP. Third, we verify that the fund is primarily focusing on U.S. equities byrequiring thepercentageofstocks in theportfolioasreportedbyCRSPtobeat least80%ormissing.For fundswherethisvariable ismissing,wecalculatethevalueofthestockholdingsfrom theThomsonholdingsdatabaseandrequire that thevalueofU.S.commonshares isatleast80%ofthefundTNA.Fourthandfinally,werequireeachfundtohaveatleast$10millionundermanagement,whichalsoservestomitigateanyincubationorreportingbias.Wemergetheremainingfunds inCRSPwiththemutualfundholdingsdatabasemaintainedbyThomsonFinancialasavailablethroughWRDSusingthemflinkslinkingfilesonWRDS.

    TheinstitutionalinvestorholdingsdatainthisstudycomesfromtheThomsonFinancialCDA/Spectrumdatabaseof SEC 13F filings.All institutional investorswith greater than $100millionof securitiesundermanagement are required to report theirholdings to the SECon

    4Specifically,werequiretheLipperProspectusobjectivecodetobeequaltoEI,EIEI,ELCC,G,GI,LCCE,LCGE,LCVE,LSE,MC,MCCE,MCGE,MCVE,MLCE,MLGE,MLVE,MR,S,SCCE,SCGE,SCVE,SESE,SGormissing;werequiretheStrategic Insight objective code to be equal to AGG, GMC, GRI, GRO, ING, SCG or missing; we require theWeisenbergerobjectivecodetobeequaltoGCI,IEQ,IFL,LTG,MCG,SCG,G,GI,GIS,GS,GSI,GS,I,IG,IGS,IS,ISG,S,SGI,SI,SIGormissing;andwerequiretheCDA/Spectrumcodetobe2,3,4ormissing.Wefinallyrequireatleastoneofthesefourcodestobenonmissing.

  • form 13F.Holdings are reported quarterly; all common stock positions greater than 10,000shares or $200,000must be disclosed starting in 1980.We obtain the institutional investorclassificationdatafromBrianBusheeswebsiteandcombinethosewiththeinformationintheThomsonFinancialdatabasetoidentifydifferenttypesofinstitutions:banks(i.e.,equitiesheldinbanktrustdepartments),insurancecompanies,investmentadvisors(includingmutualfundsforretailandinstitutionalclients),hedgefunds,pensionfundsandother(mostlyendowmentsandunclassifiedinstitutions).

    Stock returns data are obtained from monthly stock data files from the Center forResearch inSecuritiesPrices (CRSP),andaccountingdataare fromCOMPUSTAT.Tocalculatetrackingerror,weusedailymutual fund returns fromStandard&Poorsand theWallStreetWebuntilSeptember1998,andafterwardsfromtheCRSPdailymutualfundreturnsdatabase.The samedata sourceswereused inCremers andPetajisto (2009) to calculatemutual fundtrackingerrors,andseethatpaperfordetails.Thefundtrackingerroristhestandarddeviationofthedifferencebetweenthedailyfundreturnandthedailybenchmarkreturnoverthepast12months.

    Weusemutual fund selfdeclaredbenchmarkswhereveravailable.The sourceof theselfdeclared benchmarks isMorningstarDirect,whichwemerge toour other data by fundticker and/or cusip. As Morningstar Direct makes available only the current selfdeclaredbenchmark and these benchmarks could change over time for a particular fund, we usehistoricalMorningstarDirectdataobtainedin2009,2011and2013,andassumethattheselfdeclared benchmarks in 2009 were applicable also before that year. If the selfdeclaredbenchmark isnotavailable,weassignabenchmarkourselvesbasedon thebenchmark indexthat has the closet fit in terms of holdings (i.e., has the lowest Active Share across allbenchmarks considered). The main advantage of this is that if we assign an incorrectbenchmark in case the selfdeclared benchmark is not available, then that only happensbecause the funds holdings actually resemble that benchmarks holdings more than theholdings of any other benchmark. Another advantage of assigning benchmarks using theminimumActiveShareisthatthisrequiresnoreturnhistoryandcantakeaccountofchangesin

  • the funds style. Finally,we verify that our results are robust to not using the selfdeclaredbenchmarks at all but only using the minimum Active Share benchmarks that we assignourselvesbasedonthemostcurrentholdings.

    The set of benchmarks includes all selfdeclared benchmarks chosen by funds in oursampleasavailableinourMorningstarDirectdata.Thebenchmarksarefromthesebenchmarkfamilies: (1) Calvert Social (1 benchmark), Down Jones (6 benchmarks, including the DJIndustrialAverage, theDJUSSelectDividend, theDJWilshire4500and theDJWilshire5000benchmarks),FTSE (4benchmarks, including theFTSEHighDividendYield,FTSERAFIUS100andMid Small 1500 benchmarks),Mergent (1 benchmark),MSCI (15 benchmarks, includingsmall,mid and large capbenchmarksplus their value and growth components),NASDAQ (2benchmarks,namely theNASDAQ100and theNASDAQCompositebenchmarks),Russell (13benchmarks, including small, mid and large cap benchmarks plus their value and growthcomponents), Standard and Poors (14 benchmarks, including small, mid and large capbenchmarksplus theirvalueandgrowthcomponents),andSchwab (2benchmarks, includingtheSchwab1000andSchwabSmallCapbenchmarks),foratotalof58benchmarks.Weverifythatour resultsare robust tousinga smaller setof19benchmarksasused inCremersandPetajisto(2009),whoonlyincludebenchmarksfromtheRussell,S&PandWilshirefamilies.

    Theholdingsofthevariousbenchmarkscomefromavarietyofsources.FortheRussellandS&Pbenchmarkfamilieswhicharethemostfrequentlyusedasselfdeclaredbenchmarks we have the official benchmark constituent weights, from Russell directly and fromCompustat for S&P. For all other benchmarks, we approximate the benchmark constituentweights by using the weights in passive ETFs and passive mutual funds with the samebenchmarks,averagedoverallavailablepassive fundswithcompleteholdings information inThomson or CRSP, analogous to the methodology in Cremers, Ferreira, Matos and Starks(2014).DailyandmonthlybenchmarkreturnsarefromBloomberg.

    Active Share measures the proportion of the funds holdings (considering only U.S.equitypositions) that isdifferent from theholdingsof the fundsbenchmark at aparticularpointintime.Itiscalculatedasfollows:

  • , , (1)

    wherewfund,i istheweightofstock i inthe fundandwbenchmark,i istheweightofstock i inthebenchmark.ActiveSharethussumsuptheabsolutedifferenceinweightsacrossallstocksthatareineitherthefundorthebenchmarkanddividesthatsumbytwo,treatingoverweightsandunderweight identically.Afundwithnooverlappingholdings inthebenchmarkshasanActiveShareof100%,anda fundwithholdingsthatare identicaltothebenchmarkholdingshasanActiveShareof0%. Ifafunddoesnot leveruporshort,theActiveSharewillbebetween0%and100%, andmeasures the sizeof the active (i.e.,different)positions as a fractionof theentireportfolio.

    FundDuration, introduced inCremersandPareek (2013), iscalculatedas follows.Wefirstcalculatethedurationofownershipofeachstock ineveryfundbycalculatingaweightedmeasure of buys and sells by a fund (either a mutual fund or an institutional portfolio),weightedbythelengthoftimethestockwasheld.Foreachstockinagivenfund,theholdingdurationmeasureiscalculatedbylookingbacktodeterminehowlongthatparticularstockhasbeenheldcontinuouslyinthatfundsportfolio.

    Wecalculate theduration for stock i that is included in the institutionalportfolio jattimeT1,forallstocks i=1 Iandall institutional investors j=1J,byusingthefollowingequation:

    jiji

    jiT

    WTt jiji

    tjiTjiTji BH

    HWBH

    tTdDuration

    ,,

    ,1

    ,,

    ,,1,,1,,

    )1()1(

    ,(2)

    where

    Bi,j=totalpercentageofsharesofstock iboughtby institution jbetweent=TWandt=T1;t,Tareinquarters.

    Hi,j=percentageoftotalsharesoutstandingofstockiheldbyinstitutionjattimet=TW.

  • i,j,t=percentageoftotalsharesoutstandingofstockiboughtorsoldbyinstitutionjbetweentimet1andt,wherei,j,t>0forbuysand

  • the FundHoldingsTurnover,which is calculatedas thepercentageofholdings that changedfromtheendofthisquartersholdingsreporttothepreviousquarterendholdingsreport(seeGaspar,Massa,andMatos,2005).

    To evaluate the performance of the fund accruing to the endinvestor, we use thebenchmarkadjustedreturnformutualfunds.AsexplainedbyCremers,PetajistoandZitzewitz(2013), subtracting the benchmark return from the netmutual fund return is a simple androbustmethod to adjust for the funds exposure to a particular style or to particular stockcharacteristics.We calculate the fivefactoralphasof thebenchmarkadjustednet returns tocontrol for any remaining exposure to the market, size, booktomarket, momentum andliquidity factors,using thedata for those factors fromKen Frenchswebsite and the tradedliquidity(PastorStambaugh)factorfromWRDS.

    Forbothmutualfundsandinstitutional13Fportfolioswecalculatetheholdingsbasedreturn.For this,weassume thatall tradesbetweenquarterlyholdings reportsaremade justbeforetheholdingsreport ismadepublic.Weupdateweightsalsoatthetwomonthends inbetweenquarterlyportfolioreportsbyadjustingtheweightsatthebeginningofthemonthforthe stock returns during themonth, in order to approximatemore closely the return of anactualportfoliowithidenticalholdingsatthebeginningofthequarter.Wecontrolforafundsexposure to aparticular styleor toparticular stock characteristicsby calculating theDGTWadjustedreturnsoftheholdingsbasedreturns.TheDGTWadjustedreturnofeachstockinthefundsportfolioiscalculatedasthedifferenceoftheCRSPmonthlystockreturnandanequallyweightedportfoliowith similar size, value andmomentum as the stock in the portfolio (fordetailsseeDaniel,Grinblatt,Titman,andWermers,1997).Finally, theholdingsbasedDGTWadjustedmonthly return of the fund is theweightedaverage return of theDGTWadjustedstock returnsusing the funds (adjusted)portfolioweights.Weagaincalculate the fivefactoralphas of the holdingsbased DGTWadjusted monthly returns to control for any remainingexposuretothemarket,size,booktomarket,momentumandliquidityfactors.

    Givenourdemandingdatarequirements(includingtherequirementofat least2yearsof holdings reports to calculate Fund Duration), we start our performance analysis for the

  • mutualfundsampleattheendof1994,andfortheinstitutionalportfoliosampleattheendof1985.Atthebeginningofeachyear,wesortfundsinto5quintileportfoliosdependingontheirFundDuration,andwithineachFundDuration(orfundturnover)quintilewesortfundsinto5quintile portfolios depending on their Active Share. We show results using both equallyweightingandvalueweightingtheperformanceofeachofthefundswithineachportfolio.Forrobustness, we also employ FamaMacBeth crosssectional as well as pooled panelperformanceregressions.

    2.2DescriptiveStatisticsoftheMutualFundSample

    Table1providesannualdescriptivestatisticsofthemutualfundsample.Thenumberoffundsstartsat239at theendof1994andclimbs to1,212 in2002,andremains fairlystablearound1,200thereafter.Themedianfundsizeequals$180millionin1994and$418millionattheendofoursamplein2013.Expenseratioshavebeenfairlystablewithamedianof1.1%peryear.Thetypicalnumberofstocksintheportfolioisabout73.ThemedianActiveShareinoursampleequals86%in1994,dropsto73%in2002,afterwhichitclimbsbackto80%attheendofthesample.About66%oftheActiveSharesarebasedontheselfdeclaredbenchmarkfromMorningstarDirect,abouthalfthesampleinthebeginningandabout90%attheend.MedianFundDurationswere1.1yearsatthebeginningofthesample,shortenedabitto0.92yearsin2001,afterwhich theyconsiderably lengthened to1.7yearsat theendof the sample.FundTurnoverRatioandFundHoldingsTurnoverfollowasimilarpattern,thoughwithlessevidenceoflongerholdingsperiodsattheendofthesamplerelativetothebeginning.Forexample,FundTurnoverRatiohasamedianof38%in1994,77%in2001anddroppingto49%in2013.

    PanelAofFigure1showsthepercentageofallTNA inoursampleattheendofeachyearbyfiverangesofActiveShare:(i)closetindexfundswithActiveShare(below60%),(ii)lowActiveShares(between60%and70%),(iii)moderateActiveSharebetween(70%and80%),(iv)highActive Share (between80%and90%),and (v) veryhighActive Share (above90%).ThepercentageofTNA incloset index fundsequals2% in1994,climbs tooverhalf theassets in2002andsteadilydropsafterthattoe.g.31%in2008andonly14%in2013.Thepercentageof

  • assetsinveryhighActiveSharefundshasbeenmorestable,withasamplehighof27%atthebeginningofoursamplein1995,alow8.5%in2001andequaling12%in2013.

    PanelBofFigure1showsthepercentageoffundsinoursampleattheendofeachyearwithanActiveShare in the same five rangesasused inPanelAofFigure1.Comparing thisfigureof thepercentageof funds to the figurebasedon TNA shows thatmost closet indexfundsintheearly2000swerelargefunds,thoughthatismuchlessthecaseattheendofoursample.A largegroupof fundshasahighActiveSharebetween80%and90%,whichgroupcomprises 28% of funds in 1994, 18% of funds in 2001 and 29% of funds in 2014. ThepercentageofveryhighActiveSharefundshassteadilydeclinedovertime,standingat38%in1994,29%in1999and22%in2013.

    Panel A of Table 2 gives basic descriptive statistics mean, standard deviation,minimumandmaximumforthemainvariablesinourpaperacrossthefullsample.PanelBofTable2presentsthetimeseriesaverageoftheannualquintilebreakpointsforsortsonActiveShareandthethreeproxiesfortradingfrequency.TheActiveSharebreakpointsshowthatthebottomActiveSharequintileportfolioconsistsofcloset indexfunds,andthetopActiveSharequintile portfolio of very high Active Share funds. On average, funds in the shortest FundDurationquintileportfolioholdstocksforatmost0.65years(lessthan8months),whilefundsinthelongestFundDurationquintileportfolioholdstocksgenerallylongerthan2years.FundinthebottomFundTurnoverRatioquintileportfoliohaveaturnoverratiobelow27%peryear,andthose inthetopFundTurnoverRatioquintileportfoliohaveaturnoverratioabove119%peryear.

    PanelCofTable2providestheSpearmanrankcorrelationmatrixofthemainvariables.ActiveShare isnothighlycorrelatedwithanyofthethreetradingfrequencyproxies,withthehighestrankcorrelationequalto 16%forFundDuration.Thetwoholdingsbasedproxiesaremosthighlycorrelated,withaSpearmanrankcorrelationof82%forFundDurationandFundHoldingsTurnover.Finally,FundTurnoverRatiohasaSpearmanrankcorrelationof70%withFundDurationandof78%withFundHoldingsTurnover.Othernotable rankcorrelationsarethatfundswithhighActiveSharetendtobesmaller(rankcorrelationof17%withTNA),more

  • expensive(rankcorrelationof29%withthetotalexpenseratio)andcontainfewerstocks(rankcorrelationof29%withthenumberofstocks).

    TableDofTable2showstheaveragepercentageofTNAinoursampleineachofthe25portfolios in the5x5 sortonFundDurationandActiveShare,witheachof the25portfolioscontainingaboutthesamenumberoffunds.FundsintheshortestFundDurationquintiletendto be small, representing on average only 9.7% of TNA, while funds in the longest FundDurationquintile representonaverage41.6%ofTNA.Abouta thirdof that represents fundsthat also are in the bottom Active Share quintile, i.e., showing that many funds with longholdingdurationsarenotveryactive.This furtherunderscores the importanceof separatingfunds in both Active Share and FundDuration (or fund turnover) dimensions. In the ActiveSharedimension,closetindexfundsinthebottomActiveSharequintileonaverageholdabout32%oftheassets inthesample,andtheveryhighActiveSharefunds inthetopquintileholdabout10%oftheassets.

    Panel A of Figure 3 provides the historical Active Share and Fund Duration for 8generally largemutual funds.These8 fundsarechosen for theirdistinctiveActiveShareandFundDurationat theendofour sample in2013,andonly serve for illustration.ExamplesoffundsthatattheendofthesamplehaveahighActiveShareandlongFundDuration(bothtopquintile),includedinthisfigure,arethetheBaronGrowthFundafter2009,theRoycePremierFundafter2005andtheArielFundalsoafter2005.AllofthesefundsgenerallyhadconsistentlyhighActiveShares,thoughexhibitedconsiderablyshorterFundDurationspreviously.ExamplesoffundswithlowActiveShareandhighDurationwouldbetheBlackrockEquityDividendFundafter2005and theFidelityMagellanFundaround2001.Both funds canalsobeclassifiedasclosetindexfundsattheendofoursamplein2013,wheretheFidelityMagellanFundhasfairlyshortFundDurationandtheBlackrockEquityDividendFundfairlylongFundDuration.

    2.3DescriptiveStatisticsoftheInstitutionalInvestorSample

    PanelAofTable3providesdescriptivestatisticsofActiveShareandFundDurationforthe institutional investorsample for19862012.ThemeanActiveShareandFundDurationacross all institutions in thepooled sample is73% and17months, respectively.As a group,

  • these institutions own 36% of public tradedU.S. equities at the beginning of our sample in1986,45%in2000and48%in2012.

    Wealso report the summary statistics separately for the followingeight typesof institutionsbasedontheclassificationschemegiven inBushee(2001):Banks(BNK),InsuranceCompanies(INS), Investment Companies (INV), Independent Investment Advisers (IIA), Public PensionFunds (PPS), Corporate Pension Funds (CPS),University and Foundations Endowments (UFE)andother.IndependentInvestmentAdvisers(IIA)arethemostactivewithameanactiveshareof77%andfurtherwithintheIIAgroup,HedgeFunds5aremostactivewithmeanActiveShareof 84%. Panel A of Figure 2 shows that the proportion of assetsmanaged by institutionalinvestorswithActiveShare lessthan60%hasgoneup from49.4% in1985to73.5% in2012.TheproportionofassetsmanagedbytheactivefundswithActiveSharegreaterthan80%hasbeenrelativelystableataround10%of totalassets (less thanhalfofwhich is in institutionalportfolioswithActiveShareabove90%).PanelBofFigure2showsthatthenumberoffundsisfairlyevenlydistributedacrossthevariousActiveShareranges,implyingthatlowActiveShareinstitutionalportfoliostendtobemuchlargerinsizethantheinstitutionalportfolioswithhighActiveShare.

    PanelsB andCof Table 3 reports thebreakdownofnumberof funds and assetsbyinstitutionaltypeandfurtherbyvariousActiveSharerangesattheendofoursampleperiod.Independent Investment Advisers is the largest group with 1,944 institutions with a totalportfolio valueof$3.47 trillionoutof totalof 2,491 institutionswith an aggregateportfoliovalue of $6.64 trillion. Hedge Funds comprised a major portion of the investment advisersgroupwith 707 fundswith totalportfolio valueof$1.28 trillion.Assets forhedge funds areconcentrated in high Active Share groups (except for Blackrock with $404 billion investedmostly inpassive fundswithanoverallActiveShareof14%, though is stillmisclassifiedasahedgefund).Othermajorgroupsofinstitutionsareinvestmentfirmswithtotalassetsof$1.05

    5We thankVikasAgarwal forkindlyprovidingus the listofHedgeFunds inThomson13Fdatabase.This listofhedge funds is based on 13F filings and ismanually classified by Agarwal, Jiang, Tang, and Yang ( 2013) andAgarwal,Fos,andJiang(2013).

  • trillionwhicharemostlycomprisedofthemutualfundcompaniesandBankswhicharelargelyinactivewith$1.1trillionundermanagementwithanaverageActiveShareof55%.

    Similarly,PanelsAandBofAppendix1presentsthebreakdownofassetsandnumberoffundsby institutional typesandFundDuration ranges.HedgeFundshave the lowestholdingdurationwithmore thanhalfof the fundswithholdingduration less thanoneyearwhereasindependentinvestmentadvisersareevenlydistributedwithFundDurationsofupto3.5years.

    Attheendofeachyear,wefirstsorttheinstitutionsintoquintilesbyFundDurationandthenwithineachFundDurationquintile,wefurthersorttheinstitutionsintoquintilesbasedontheir yearend Active Share. Panel D of Table 3 reports the average percentage of totalinstitutionalinvestorstockholdingsineachofthese5*5portfoliossortedbyHoldingDurationandActiveShare,averagedacrosstime.Eachoftheseportfoliosincludes4%oftotalnumberofinstitutions in each year but may differ in the amount of assets depending on the size ofequitiesundermanagementattheinstitutionsineachoftheseportfolios.ThelowActiveShareandhighFundDurationportfolio(bottomandtopquintile,respectively),i.e.,withpassivelongterminstitutions,comprisesof20.5%oftotalinstitutionalinvestorportfoliovalue.InstitutionswithhighActiveShareand longFundDuration (both topquintile)hold2.1%ofallassetsonaverage,jointlyholdingequitiesworth$93.2billionintheirstockportfolioattheendof2011.

    Panel B of Figure 3 gives some examples across time of large institutional investorswhoseActive Share and FundDurations are distinctive. These examples are only chosen asillustrative.Theportfolioofpubliclytradedstocksasreportedinthequarterend13FholdingsofBerkshireHathawayshowsageneral loweringoftheActiveShareovertime,while itsFundDuration isabout3years from19871992andagainafter2007,but reachedover4yearsaround19972002.Other large institutions thatcombineagenerallyhighActiveShareandlong Fund Duration are Gardner Russo & Gardner, SPO Partners & Co., Ruane Cunniff &Goldfarb,EarnestPartnersandColumbiaWangerAssetManagement.BlackrocksActiveShareisgenerallylowandhasparticularlydeclinedafter2007, indicatingthegrowing importanceofpassiveproducts.Thequarterend13FportfoliosreportedbyBankofAmerica,GoldmanSachsandJPMorgancanallbeclassifiedasclosetindexfunds.

  • Panel C of Figure 3 shows the Active Share and FundDuration of nine hedge fundsacrosstime,againsolelyforillustrativepurposes.HedgeFundswhosequarterend13Fholdingsexhibit high Active Share and long Fund Duration only MHR Fund Management, WayzataInvestmentPartners,FortressInvestmentGroupandTPGCapital.Hedgefundswhosequarterend 13F portfolios indicate fairly low Active Shares and short Fund Durations include AQRCapitalManagement(especiallyafter2008),D.E.ShawandCitadelInvestmentGroup.TheirlowActiveSharesdonotmeanthatthesehedge fundsdonottendtotakemarketpositionsthataresubstantiallydifferentfromsomebenchmark index.Aspreviouslymentioned,quarterendportfolioswithfairlyshortFundDurationsare inherently lessreflectiveofthe longsideofthetradingpositions,astheshortFundDurationshowsthataconsiderablypartoftheinstitutionstrading is likelyround tripwithin thequarter.Therefore, theirquarterendholdingsare likelymuch less informativeabout the funds tradingstrategyrelative to institutionswithgenerallylongFundDurations.

    3.PatienceProxies,ActiveShareandFundPerformance

    A.MutualFundPerformance

    Sortingallmutual funds into5x5portfoliosbasedonFundDurationandActiveShareresultsin25portfolios.UsingmonthlyperformancedatafromJanuary1994toDecember2013,wefirstconsidertheequallyandvalueweighted(bytotalnetassets)performanceofthefundsin theseportfolios.PanelA (B)ofTable4provides the fivefactoralphasof thebenchmarkadjustednetfundreturnsusingequally(value)weightedportfolios,andPanelC(D)ofTable4provides the benchmarkadjusted returns themselves again using equally (value) weightedportfolios.

    Amongallportfoliosof funds,onlythemostactiveandpatientlymanaged fundshaveonaveragebeenabletooutperformtheirbenchmarksinoursample.Activeandpatientfundsaredefinedasthosewhoseholdingsaresubstantiallydifferentthanthebenchmarks(i.e.,havehighActiveShare)andwhotraderelativelyinfrequently(i.e.,theyhavelongholdingdurationsor low portfolio turnover). The outperformance of themost active and patient funds theportfolioofmutual fundswhereboth theActiveShareand theFundDurationare in the top

  • quintile iseconomicallyconsiderableandstatisticallystrong.Asshown inPanelCofTable4usingequallyweightedportfolios,thesepatientfundsbeattheirbenchmarksinthe12monthsfollowingportfolioconstructionby1.76%peryear(tstatof1.98)aftercosts.

    Adjustingthebenchmarkadjustednetreturnsforexposuretothefivefactors(market,size, booktomarket,momentum and liquidity) increases the outperformance to 2.30% peryear(tstatof3.14),asshown inPanelAofTable4.Valueweightingtheportfoliosofmutualfundsgivessimilarresults,albeitwithweakerstatisticalsignificance(outperformanceof1.86%peryearandatstatof1.66afterbenchmarkadjusting,seePanelDofTable3,andof1.85%peryearandatstatof1.88afteralsoadjustingforexposuretothefivefactors,seePanelBofTable 4). Theweaker statistical significancemay be due to a few large funds dominating aportfoliooffunds,giventhelargeskewinfundsize.

    The most active mutual funds with short durations or who frequently trade weregenerally unable to outperform their benchmarks. Rather, we find that mutual funds thatfrequently trade on average underperformed their benchmarks by a considerable margin,acrossall levelsofActiveShare.Forexample, theequallyweightedportfolioofmutual fundwithshortFundDurationandlowActiveShare(bothinthefirstquintile)underperformedtheirbenchmarksconsiderablywithanabnormalreturnof2.46%peryear(tstatof5.57seePanelAofTable4).Theunderperformanceof theanalogousportfoliowith shortFundDurationandhighActiveShare(inthetopquintile)similarlyunderperformedwithanannualabnormalreturnof1.94%(tstatof2.45,againseePanelAofTable4).Wethusfindthatonlyactivebetsthatwerealsopatient (or longerterm)were rewarded in themarkets,but findnoevidence thatactiveshorttermbetswereprofitable.

    Further,theresultsforoursampleconfirmthatActiveShareisusefulforpickingactivemanagers, but find less evidence that highActive Share alone is generally sufficient to findmanagerswho outperform their benchmarks.We replicate themain result in Cremers andPetajisto(2009)thathighActiveSharefundsoutperformlowActiveSharefunds.However,wedo not find that high Active Share funds as a group have economically and statisticallymeaningfuloutperformance,butonlyhighActiveSharefundsthatalsohavelongerinvestment

  • durations.Unconditionally,thefundsinthetopActiveSharequintiletendtooutperformtheirbenchmarks on average for equallyweighted portfolios, but this outperformance ismodesteconomically (e.g.,25basispointsperyearalpha inPanelAofTable4)andnot statisticallysignificant(tstatisticof0.45).Furthermore,theoutperformanceofthehighActiveSharefundsis on average negative using valueweighted portfolios, showing that large funds with highActiveShare(whoarenaturallyweightedmoreheavily inthevalueweightedportfolios)werelesslikelytooutperform,asalsofoundinCremersandPetajisto(2009).6

    LongerFundDuration isassociatedwithbetterperformance,andespecially for largerfunds. Across all Active Share quintiles, funds with long Fund Duration (top quintile)considerable and statistically significantly outperformed funds with short Fund Duration(bottom quintile) for valueweighted portfolios. The stronger positive association betweenperformanceandFundDuration for larger funds isconsistentwith those larger fundshavingmorepriceimpactwhentheytrade.

    Holding stocks for a relatively long period is in itself on average not associatedwithmanagerialskillorsignificantoutorunderperformance,andtheonlyportfolioswithlongFundDuration that outperform are those that also contain high Active Share funds. Theunconditionalportfolioof funds in the topFundDurationquintilehasaneconomically smallandstatisticallyinsignificantabnormalreturn.ThissuggeststhatthepositiveabnormalreturnsdocumentedbyCremers,SautnerandPareek(2014)forportfoliosofstockssortedbyduration(i.e.,averagingFundDurationoverallfundsowningthestock,usingthedollaramountinvestedbyeachfundinthestockastheweights)isduetothestockselectionskillsofthemostactivefundsratherthantosomestockrelatedanomaly.

    ActiveSharemattersmostamongfundswith longFundDurations,whileamongfundswithshortFundDurationsthedifference intheperformancebetweencloset index fundsandhighActive Share funds iseconomically small and statistically insignificant. Forexample and6WecanreconcileourresultsfromthoseinCremersandPetajisto(2009),whoreportedafourfactoralphaforthehighestActiveSharequintileportfolioof1.15%peryearwitha tstatisticof1.86, from thedifferences in timeperiod.CremersandPetajisto (2009) show results for19902003,whileour time seriesextends from19952013. Inour sample, thecumulativeabnormal returnof the topActiveSharequintileportfolioequals4% from1995totheendof2003,butisnegative2%from2004totheendof2013.

  • usingequalweighting,thelongshortportfoliothatislonginfundswithhighActiveShareandlongFundDuration (bothtopquintile)andshorts fundswith lowActiveShareand longFundDurationhasanannualizedalphaof4.32%(tstatof5.18).Incomparison,theanalogouslongshorthighlowActiveShareportfolioconditionalonshortFundDuration(bottomquintile)hasafivefactoralphaof0.44%peryear(tstatof0.57).

    PanelAofFigure4showsthecumulativeabnormalnetreturnsofa$1investmentinthefourmutual fund portfolios defined by the extremes in the 5x5 sort on FundDuration andActiveShare.Asshowninthefigure,the$1investmentintheportfolioofmutualfundsattheend of 1994 would have outperformed a $1 investment in the portfolio of respectivebenchmarks over 40% over our time period,while the other portfolios underperformed thebenchmarks.

    One possible interpretation of these results is that fundmanagerswith very distinctportfolios(i.e.,withhighActiveShare)whoalsotradealotmaybeoverconfident.Alternatively,fundsinthetopActiveSharequintilemaybefocusingonrelativelyilliquidstocks(i.e.,relativeto the stocks in thebenchmark), and frequent trading in those stocksmay significantlyhurtperformance. This would mean that the impatient and very active fund managers aredemandingcostly liquidityprovision.Insubsequentanalysis,wetrytoshedfurther lightuponthesealternativeexplanations.

    Forrobustness,wealsoconsidertwoalternativeproxies forhowpatientthe investingstrategyofthefundis,andtheseresultsconfirmthattheoutperformancetendstobestrongestforfundswithhighActiveSharesthattrademorepatiently.First,PanelAofTable5containsthefivefactoralphasbasedonnetbenchmarkadjustedreturnsforequallyweightedportfoliosinadoublesortofFundTurnoverRatioandActiveShare,andPanelBofTable5presentstheanalogousresultsforthedoublesortofFundHoldingsTurnoverandActiveShare.

    Usingeitherproxy,wefindthatoutofthe25portfolios,theonlyportfolioswithpositivealphasarethosewithfundsinthetopActiveSharequintileandthebottomthreequintilesforthealternativepatienceproxy.Forexample, theportfoliowithhighActiveShare (quintile5)andlowFundHoldingsTurnover(quintile1)hasanannualizedalphaof1.44%withatstatistic

  • of1.91.TheportfoliowithhighActiveShare(quintile5)andlowFundTurnoverRatio(quintile1)hasaneconomicallymeaningfulalphaof0.90%peryear that is insignificant (tstatisticof1.10),while theportfoliowithhighActive Share (quintile5) andnextlowest Fund TurnoverRatio(quintile2)hasanannualizedalphaof1.07%that isstatisticallysignificant(tstatisticof1.82).

    Usingeither turnoverproxy,we find that funds that trademore tend tohavegreaterunderperformance,andespeciallysoforfundsthatalsohaveahighActiveShare.First, inthesinglesortonFundTurnoverRatio, theportfolioof funds trading themost (quintile5)hasafivefactoralphaof1.58%peryear(tstatisticof2.81),whilethequintile1portfolioexhibitsnosignificant underperformance (alpha of 0.38% per yearwith a tstatistic of 1.05). Similarly,usingFundHoldingsTurnoversinglesorts,thequintile5portfoliohasanannualizedalphaof1.97% (tstatistic of 4.29) and the quintile 1 portfolio has an annualized alpha of 0.14% (tstatistic of 0.39). In both cases, the difference in performance across the quintile 1 and 5portfoliosisstatisticallysignificantaswell.

    The final robustness check for the main result in this section using net benchmarkadjustedreturnsistorun19annualFamaMacBethpredictivecrosssectionalregressionsoftheyearly net benchmarkadjusted fund return on various fund characteristics,with theirmeancoefficientspresented inTable6.Theseregressionsallowustocontrolforseveralotherfundcharacteristicssuchastrackingerror,the logoffundsizeandtheexpenseratio,andtoverifywhether the outperformance of the funds with high Active Share and relatively infrequenttrading is robust across years.We enable an easy comparison to the portfolio approach byfocusingontheHigh(Low)ActiveSharedummy,whichequals1ifthefundsActiveShareisin the top (bottom)quintile that year,plus the interactionsof these twodummieswith thethreepatienceproxies.Aspreviouslyalsoshown inthedoublesorts,fundperformance inoursample isnot linearlyrelatedtoActiveShareandtheproxiesfortradingfrequency,suchthatusing Active Share itself rather than the dummies does not produce statistically significantresults.

  • Column (1)ofTable6 shows that fundswithhighActiveShare tended tooutperformtheirbenchmarksbyabout79basispoints,thoughwithoutstatisticalsignificance(tstatisticof1.45).Likewise,noneofthe3patienceproxiesaresignificantlypredictiveoffundperformance.InColumn (1),theonly fundcharacteristicstronglyrelatedto future fundperformance istheexpenseratio, indicatingthatmoreexpensivefundsperformedworseonaverage.Column(2)showsapositiveandstatisticallysignificantcoefficientfortheinteractionofHighActiveShareand FundDuration, Column (3) for the interaction ofHigh Active Share and Fund TurnoverRatio,andColumn(4)fortheinteractionofHighActiveShareandFundHoldingsTurnover.Thisconfirms thatonlymutual fundswithhighActiveShare thatalsopursuedpatient investmentstrategieswereabletooutperformtheirbenchmarksinoursample.

    Next,weevaluatethefundperformanceusingtheholdingsbasedgrossreturns,whichis lessrelevanttoend investorsbut is informativeaboutmanagerialskillbeforetradingcostsandotherexpensesare incurred.Asdescribed inSection2,wecalculate theDGTWadjustedholdingsbasedreturns,andcontrol foranyremainingexposure to thestandardmarket,size,booktomarketandmomentumfactors.Table7showstheresultsfortheequallyweighted5x5double sort on Fund Duration and Active Share. One noticeable change from the previousresultsisthatonceweuseDGTWadjustedgrossreturns,wenolongerseemanyportfoliosinthe double sortwith economically and statistically significant negative alphas. This indicatesthatmanymanagershaveon averagemanagerial skill,even if (againon average)notmanyinvestors benefit from those in the form of net performance that is superior to theperformanceofthebenchmark.

    TheonlyportfoliosexhibitingapositiveandstatisticallysignificantalphafortheDGTWadjusted gross returns is the portfolio with high Active Share (quintile 5) and high FundDuration (quintile 5),with an annualized fivefactor alpha of 1.26% (tstatistic of 1.94). Thisconfirmsthemainresultthatactiveandpatient investorsoutperform.BothActiveShareandFundDurationmatter.Similar to theprevious resultsusingnetbenchmarkadjusted returns,fundswith longFundDurationtendtooutperformfundswithshortFundDuration,especiallywhenActiveShare ishigh.Forexample,the longshortportfoliobuying (stocks in)fundswith

  • longFundDurationandselling fundswithshortFundDurationunconditionallyhasa4factoralphaof1.21%peryear (tstatisticof2.31) in the single sort,declining to0.60%peryear (tstatisticof1.62)forfundsthatarealso inthebottomActiveSharequintileand,alternatively,rising to 2.38% per year (tstatistic of 3.28) for funds that are also in the top Active Sharequintile.

    Previously,wehad raised twoalternative interpretationsof theunderperformanceofvery active managers with short investment horizons: overconfidence versus a focus onrelatively illiquid stocks.TheDGTWadjusted gross returns areuseful todistinguishbetweenthesealternative interpretations,asgross returnsarenotaffectedby trading costsor costlyliquiditydemands from impatient trading.Comparing the alphasusingDGTWadjusted grossreturnsinTable7totheanalogousalphasusingbenchmarkadjustednetreturnsinPanelAofTable3suggeststhatlowActiveSharefundslosemoreintradingcostsandotherexpensesthanhighActiveSharefunds.Thiscastsdoubtontheliquidityexplanation.Wewillempiricallyrevisitboth interpretations inSection4,byexploringwhatstrategiesthepatientmanagerswithhighActiveShareusedtosubstantiallyoutperform.

    B.InstitutionalPerformance

    This subsection uses the institutional 13F stock holding reports to evaluate theperformanceofaggregated institutional fundsbasedonDGTWadjustedgrossholdingsbasedreturns.Asfarasweknow,wearethefirsttoexploretheabilityofActiveShareanddifferentproxies for the trading frequency to predict the performance of the stocks held by theseinstitutions.PanelAofTable8reportstheequallyweightedfivefactoralphasina5x5sortsonActiveShareandFundDuration,andPanelBofTable8reports theequallyweightedDGTWadjustedreturnsthemselveswithoutadjustingtheseforanyremainingexposuretothemarket,size,booktomarket,momentumandliquidityfactors.

    Theunconditional sortsonActive Share indicate thatactivemanagershad significantmanagerialskill,withthestocksheldbythe institutions inthetopquintileportfolioofActiveShare outperforming considerably,with an annualized 5factor alpha of 2.10% (tstatistic of2.75)andaDGTWadjustedreturnof1.15%peryear(tstatisticof2.36).Astheseinstitutional

  • holdingsreportsareatanaggregatedlevelandincludingsubstantiallylargerassetsthanthosecovered in the retailmutual fund database considered in the previous section aswell as inCremersandPetajisto(2009),theseresultsaretoasignificantextentanoutofsampletestforthe ability of Active Share to predict outperformance. The other five Active Share quintileportfoliosshowstatisticallyinsignificantperformance.

    TheoutperformanceofthehighActiveSharemanagersislargelyduetoinstitutionswiththelongestinvestmenthorizons.ForexampleandasshowninPanelAofTable8,theportfolioof institutionswithhighActiveShare (quintile5)andshortFundDuration (quintile1)hasanannualized 5factor alpha of 0.40% (tstatistic of 0.50),while the portfoliowith high ActiveShareandlongFundDuration(quintile5)hasanannualalphaof2.22(tstatisticof4.10).Weillustrate the substantialoutperformanceof theholdings in institutionalportfolioswithhighActiveShareandlongFundDurationinPanelBofFigure4.

    Stocks inhighActive Share (topquintile) institutionsoutperform stocks in lowActiveShare (bottom quintile) institutions, but the difference in performance is only economicallylargeandstronglystatisticallysignificantforinstitutionsthatalsohavelongFundDuration.Forexample, among short FundDuration institutions (bottom quintile), the longshort portfoliothat is long (short) institutionalportfolioswithhigh(low)ActiveSharehasa5factoralphaof0.65%peryear(tstatisticof0.84),whiletheanalogous longshortportfolioamong longFundDuration institutions (topquintile)hasa5factoralphaof2.07%peryear (tstatisticof3.85).Similarly,thedifferencebetweentheperformanceoftheshortandlongFundDurationquintileportfolios for thehighActiveShare (topquintile) institutions iseconomicallymeaningfulandstatistically significant, but is insignificant for the other Active Share quintiles. Results usingDGTWadjusted returns in Panel B of Table 8 are similar, ifwith generally (slightly)weakerstatisticalsignificance.

    PanelCofTable8 shows robustness resultsusingadouble sortof all institutionsonFundHoldingsTurnoverandActiveShare.Weagainfindthatthebestperformanceisachievedby theportfolioswithhighActive Share (topquintile) and low FundHoldings Turnover.Thethree portfolios with top quintile Active Share and bottom three quintiles Fund Holdings

  • Turnoveraretheonlythreeportfolioswithpositiveandstatisticallysignificantperformanceinthe 5x5 sort (though the performance among these 3 portfolios is not statistically differentfromeachotheror from theperformanceof theportfoliowith topquintileActiveShareandtopquintileFundHoldingsTurnover).

    Table9focusesonthesampleofhedgefunds.AsdiscussedinSection2.3,hedgefundsarean importantsubsetof institutions thatat theendofour timeseriesconstitutesaboutaquarter of the observations in the institutional sample and about a fifth of the assets. Asdiscussedpreviously,westartourhedgefundsample in1995.Quarterendholdingsofhedgefunds tend tohavehighActive Share (medianof89%),andoftenwithoutmuchpersistenceovertime(medianFundDurationofaround9months).Twomajorlimitationsinevaluatingtheperformanceofhedgefundsarethatweonlyobservethelongpositions(whileshortpositionsmaybeevenmoreimportantformanyhedgefunds)andonlythequarterendpositions(whileroundtrip trades within the quarter may make up the bulk of their trading activity).Nonetheless,ashedge fundsareamong themostactiveandunconstrained institutions,andfastgrowing insizeandnumber, it isworthconsideringhowtheirActiveSharesandpatiencearerelatedtotheirholdingsbasedperformance,evenifbasedonquitelimiteddata.InTable8,we use a 5x3 sort on Fund Duration and Active Share (rather than a 5x5 sort) due to theconsiderably lower number of institutions and reduce noise. We report 5factor alphas ofDGTWadjustedreturns,thoughresultsusingDGTWadjustedreturnsthemselvesaresimilar.

    Hedge fundquarterend longholdings significantlyoutperform if theirportfolioshavehigherActiveShare.IntheunconditionalsortofhedgefundsinActiveSharetercileportfolios,thelowActiveSharetercileportfoliohasa5factoralphaisbasicallyzero,whilethehighActiveShare tercile portfolio has a 5factor alpha of 1.52% per yearwith a tstatistic of 2.08. ThedoublesortindicatesthatthisismorelikelytobeduetohedgefundswithlongFundDuration.Whilealphasarenotmonotonicacrossthe fiveFundDurationquintileswithinthetopActiveSharequintile,amongthosetheonlyportfoliowithapositiveandstatisticallysignificantalphaistheportfoliowithlongestFundDuration,withaneconomicallyremarkable3.64%peryear(tstatisticof3.04). We illustrate the substantialoutperformanceof the longonlyquarterend

  • holdings inhedgefundportfolioswithhighActiveShareand longFundDuration inPanelCofFigure4.

    A final robustness check is given in Table 10 using FamaMacBeth predictive crosssectionalregressionsofDGTWadjustedholdingsbasedannualreturnson lagged institutionalcharacteristics.Columns(1)(3)usethesampleofallinstitutionalportfoliosandcolumns(4)(6)usethesampleofhedgefundsonly.Incolumn(1),wefindthathavingahighActiveSharepredictsanoutperformanceof0.79%peryear (tstatisticof2.31)and lowActiveShare fundspredicts an underperformance of 0.28% per year (tstatistic of 1.68, and thus marginallyinsignificant).Column(2)addstheinteractionsoftheHighandLowActiveSharedummieswithFund Duration, and finds strong evidence that the outperformance of high Active Shareinstitutions is due to those that also have longer Fund Duration. The coefficient of theinteractionofFundDurationandHighActiveShareequals0.64%(tstatisticof3.16),andonceitis included thecoefficienton theHighActiveSharedummy itselfbecomesveryclose tozeroandinsignificant.Economically,astandarddeviationincreaseininstitutionalholdingdurationisassociatedwitha55basispoints(=0.86x0.64%)higherperformanceamonghighActiveShareinstitutions. Column (3) robustly confirms that institutionswith high Active Share aremorelikelytooutperformiftheytradelessusingthealternativeproxyofFundHoldingsTurnover.

    TheFamaMacBethregressionsforthehedgefundsamplelikewiseshowrobustnessofour main result that hedge funds with higher Active Shares tend to have better futureperformance, and especially if they also have longer holding durations or less quarterendturnover.Asthesampleissmallerandstartsonlyin1995,statisticalsignificanceisabitweakercompared to the full sample of all institutions, especially using Fund Holdings Turnover.Economically, the results are strong. For example, the interaction coefficient in column (5)indicates that a standarddeviation increase in FundDuration is associatedwith a 138basispoints(=0.86x1.6%)higherperformanceamonghighActiveSharehedgefunds.FundDurationdoes not seem to predict performance for low Active Share hedge funds, which tend tounderperformbyabout90basispoints.

  • C.WhathelpsexplaintheoutperformanceofthehighActiveShareandpatientfunds?

    ThissubsectionconsidershowtoexplainthemanagerialskillshownbythefundswithhighActiveSharethattradeinfrequently.Weaimtodosobyregressingthemonthlyreturnsofthe top quintile Active Share and Fund Duration portfolios on seven different factors tomeasuretheportfoliosexposuretodifferentgroupsofstocks.Westartwiththebenchmarkadjustedreturnsfortheportfolioofmutualfundswiththemostpatientanddistinctportfolios,andpresentresultsinPanelAofTable11.

    Column(1)doesnot includeanyfactorandreportsanannualizedbenchmarkadjustedreturnof1.92%(tstatisticof2.08),correspondingtotheresultinPanelCofTable4.Addingthemarketfactorincolumn(2)increasesthealphasubstantiallyto2.63%(tstatisticof3.01).Thisindicates that thepatient and activemanagers tend tobuy stockswith lowermarketbetas.Column(3)showsanegativeloadingonthesizefactor,suggestingthattheseportfoliostendtobuylargerstocksrelativetothebenchmark.Thepositiveloadingonthebooktomarketfactorin column (4) indicates that active and patient managers tend to be value managers.Economically, exposure to the booktomarket factor seems important, explaining about 54basispointsayear(=2.92%1.36%).Next,theportfoliohasanegativeloadingonmomentumin column (5) that increases the alpha to 2.22% a year (tstatistic of 2.46), suggesting acontrariantendencythatalsomoderatelymattersforthealpha.ThetradedsystematicliquidityfactorproposedbyPastorandStambaugh(2003)doesnotplayasignificantroleincolumn(6).

    Column(7)confirmsthatactiveandpatientfundstendtobuylowbetastocks,andthatthisexposureisbettercapturedbytheBettingagainstBeta(BaB)factorintroducedbyFrazziniandPedersen(2013)thanbythemarketfactor.RegressingthebenchmarkadjustednetreturnsonaconstantandtheBaBfactorgivesastatisticallyinsignificantalphaof0.92%peryearwithatstatisticof1.07.Column(8)showsthatamajorpartofthemanagerialskillisfurthercapturedbythe QualityminusJunk (QmJ) factor introducedbyAsness,Frazzini,andPedersen (2013).TheregressiononaconstantandtheQmJfactorresultsinanannualizedalphaof1.18%withatstatisticof1.38.

  • Column(9)showsthe5factorresultscorrespondingtoPanelAofTable4,withanalphaof2.30%peryearwithatstatisticof3.14.Thenext3columnsshowthatbothBaBandQmJfactorshelptoreduceandthusexplainthisalpha,withcolumn(11)suggestingthatmostofthereduction fromthe5factoralpha incolumn (9)comes fromcontrolling forexposuretohighqualitystocksasmeasuredbytheQmJfactor.Inparticular,the7factormodelsthatincludesallfactors consideredhereproducesanannualizedalphaof0.59%peryearwitha tstatisticof0.83,whichconstitutesreductionof74percentagepointsofthe5factoralpha.

    We thus conclude that themanagerial skill from themost active andpatientmutualfund managers is quite similar to that manifested by Warren Buffett, as documented byFrazzini,KabillerandPedersen (2013).Theydocument thatBerkshireHathaway,managedbyWarren Buffett, as well as Berkshires public equity holdings identified from quarterly 13Fholdingshavesignificantlypositivealphasthatbecome insignificantonlywhencontrolling fortheir exposure to BaB andQmJ.Our results thus indicate thatWarren Buffetts skill seemsgenerallysharedbymutualfundmanagersinthetopActiveShareandFundDurationquintiles:the clearmajorityof theiroutperformance seemsdue to theirpicking safe (lowbeta),value(highbooktomarket)andquality(profitable,growing, lessuncertainty,higherpayout)stocksandholdingontothoseoverrelativelylongperiods.

    Next,weconsiderwhethertheperformanceofthemostactiveandpatientinstitutionalportfoliosislikewiseexplainedbytheirbuyingofsafe,valueandqualitystocks.Asindicatedbycolumns (1) (3) inPanelBofTable11,wedonot findevidence for this.Startingwith theaverageDGTWadjustedreturnof1.88%peryear(withatstatisticof3.49)incolumn(1)seealsoPanelBofTable8addingallsevenfactorsonlyreducesthealphato1.73%peryear(withatstatisticof3.06)incolumn(3).WethusconcludethatWarrenBuffettsstyleascapturedbytheBaBandQmJfactorsasinFrazzini,KabillerandPedersen(2013)isnotgenerallysharedamongotherinstitutionswhoinvestactivelyandpatiently.

    Finally,columns(4)(6)ofTable11,PanelBfocusesontheperformanceofthestocksinthequarterendportfoliosofthehedgefundswithhighActiveShareandlongFundDuration,whohaveanaverageDGTWadjustedoutperformanceof3.53%peryear(seecolumn(4)).We

  • find that about a thirdof thisoutperformanceor1.2%per year, see column (6) canbeexplainedbybuyingvaluestocks,beingcontrarianwithalargenegativeloadingonmomentum,andbuyingqualitystockswithalargepositiveloadingonQmJ.LiketheoutperformanceofthehighActiveShareandpatient institutions,we leave theexplanationof the remainderof thisoutperformancebythesehedgefundsforfutureresearch.

    4.Conclusion

    This paper documents that both Active Share and trading frequently and theirinteractionare importantdimensionstoexplainandpredicttheabilityofstockportfoliostooutperform. For both retail mutual funds and general institutional portfolios, we find thatamonghighActiveShareportfoliosonly thosewithpatient investmentstrategiesareable tooutperform their benchmarks on average. Funds which trade frequently generallyunderperformtheirbenchmarks,regardlessofActiveShare.

    Thismeans that among funds that infrequently trade, it is crucial to separate closetindex fundswhoseholdings largelyoverlapwiththebenchmark fromtrulyactive fundswhoseholdingsarealmostcompletelydifferentfromtheirbenchmarkswithhighActiveShares.Economically,ourresults indicatesubstantialbenefitsfromthe investmentskillofhighActiveSharemanagersthattradeinfrequently.Theaverageoutperformanceofthemostpatientanddistinctportfolios(usingquintilesorts)equals2.30%peryearnetofcostsforretailmutualfunds(tstatisticof3.14). Compoundingthis2.30%annualoutperformanceoverthe19yearsoverwhichitisestimated(19952013)givesacumulativeoutperformanceof54%.Stocksheldbypatientandactive institutions ingeneraloutperformby2.22%peryear(tstatisticof4.10)andbyhedgefundsinparticularby3.64%peryear(tstatisticof3.04),bothgrossofcosts.

    The average underperformance of retail mutual funds that frequently trade andgenerallyholdstocksforlessthan7monthsarelikewiseeconomicallysubstantial.Forexample,theportfolioofmutualfundswithshortFundDurationand lowActiveShare(both inthefirstquintile)hadanabnormalnet returnof 2.46%peryear (tstatof5.52),which compounded

  • overour19yearperiodfrom19952013wouldaccumulatetoatotallossof38%oftheinitialamountinvestedrelativetoapassiveinvestmentinthemarketatnocost.

    OurresultssuggestthatU.S.stockmarketsmaybetoo informationefficient,withtoomuchcompetitionamongactive investorsortoomuchprice impactof informationtrades,forinvestors to systematically benefit from frequently trading mutual fund managers pursuingshortterm predictability. At the same time, our results also suggest that one can ex anteidentifyadistinctivegroupoffundmanagersthatseemtoexhibitsubstantial investmentskillwhenmeasuredoversufficientlongperiodsoftime.ThisisthegroupofpatientfundmanagersthatsticktotheirconvictionsandcombineahighActiveSharewith infrequenttrading.Inour5x5sortof retailmutual funds, theoutperformance isstrongest in the2portfolioswithhighActiveShare (topquintile)andtop40%ofFundDuration (top2quintiles),constituting8%offundsandonaverageabout6%ofassetsinoursampleofretailmutualfunds.

    How did these patient and active mutual fund managers outperform? Perhapsunsurprisingly, their outperformance can largely be explained by their focus on stocks thatotherinvestorsshunorfindlessattractivefortheirimpatientstrategies:pickingsafe(lowbeta),value (high booktomarket) and high quality (profitable, with growing profit margins, lessuncertainty,higherpayout)stocksandthenstickingwiththoseoverrelativelylongperiods.OurfindingsthussuggestthatWarrenBuffettsinvestmentskill(seeFrazzini,KabillerandPedersen,2013)seemsgenerallysharedbytheseretailmutualfundmanagersinthetopActiveShareandFundDurationquintiles.

    We have less success in explaining the large gross outperformance of institutions especiallyhedge fundswithhighActiveShareand longFundDuration.Thisgroup includesBerkshireHathaway,probably thebest knowpatient investor, formuchofour timeperiod.However,we find thatBerkshireHathawaypublicequityholdings in the last10yearsofoursamplearenolongerverydistinctfromthemarketportfolio(withanActiveSharearound80%since2007andaround70%attheendofoursample in2012).BerkshireHathawayremainsapatient investor in public equities, even though the holding duration of public stocks in thequarterend13FreportsofBerkshireHathawaysportfoliohasshortenedfromover4years in

  • 2002 to a bit over 3 years. Frazzini, Kabiller and Pedersen (2013) show that BerkshireHathaways remarkable performance can largely be explained by exposure to safe and highqualitystocks,whichwe likewisedocumentforpatientandactivemutualfunds.However,wefindthatexposuretolowbeta,booktomarketandqualityfactorsexplainsonlyasmallfractionoftheoutperformanceofthestocksinthequarterendportfoliosofhighActiveShareandlongFundDurationinstitutionsandhedgefundsgenerally.

    We thus leave the the investment skillofpatient institutionswithverydistinctpublicequityportfolioslikeRuaneCunniff&Goldfarb,GardnerRusso&Gardner,SPOPartners&Co,for example, as largely unexplained. The investment skill of the fund managers at theseinstitutionsmaynotbeeasilycapturedinquantitativefactorsormaychangesubstantiallyovertimedependingonthecircumstances.Perhapstheirsuccessdependsonbeingtrulypatientandcontrarian,willing towait yearsbeforedeploying cash in aworldwhere typical institutionalportfolioshave100%turnoverbasedonquarterendholdings(andthusignoringanyroundtriptradingwithinquarters).Relatedly,perhapstheseinstitutionsaretooidiosyncraticanduniquetosummarizetheircollective investmentskillaswecanforthemostactiveandpatientretailmutualfunds.

    At the same time, the outperformance we document is based on publicly availablequarterendportfolioholdingsthatanyonecaneasilyaccessontheSECwebsite.Thissuggeststhat other market participants may be either unaware of the persistent success of theseinstitutions, or, if they are aware, other market participants may underestimate theirinvestmentskill.

    Or,alternatively,evenifothermarketparticipantsseeandappreciatethetrackrecord,theymaysimplybediscouragedbecauseoftheirown lackofpatience.Asaresult,conditionssuchashavingastableinvestorbaseandarelativelackofpersistentcopycatsmayallowtheseinstitutionstobeuniqueandpatient(and,itturnsout,outperform).

    How patient does one need to be? In Panel A of Figure 4, plotting the cumulativeabnormaloutperformance forportfoliosofmutual funds shows that theportfolioofmutualfundswithhighActiveShareand longFundDurationoutperformedonlyslightly inthe first5

  • years(19951999),thensubstantialoutperformancewasachievedin2000,withagainlittlegainin the 8 year period of 20012008, after which again substantial outperformance followed.PanelCofFigure4showssimilarlythat forhedge fundsoneneededtobepatience fromthemiddleof2000 to theendof2008before thequarterendholdingsof thepatient andhighActive Sharehedge funds substantiallyoutperformed.PanelBof Figure4 for all institutionsindicates that the portfolio of high Active Share and long Fund Duration institutionsoutperformed quite consistently over time. However, thismasksmuch dispersion and timevariationwithintheportfolio,asshown inPanelDofFigure4,whichpresentsthecumulativeabnormalreturnsforsomeofthe largest institutionswith longFundDurationandhighActiveShare. These figures underscore that both fundmanagers and investors sometimes need towaitseveralyearsbeforegettingrewardedfortheirpatience.

    A good example of an institutionwith a very active and patient approach is Ruane,Cunniff&GoldfarbInc.,managerofe.g.theSequoiafundthattypicallyinvestsinahandfulofpublicly traded stocks. The large idiosyncratic element in their investment strategy couldillustratewellwhy trying toexplain theiroutperformance ishard ifnot impossible, i.e.,highActive Share, patient institutions may generally be very distinct from each other andidiosyncratictothemarket.Thisdoesnotmeanthatthereisnoparticularinvestmentstrategy.Forexampleforthe investmentstrategyoftheSequoiafund,apreferenceforstocksthatcanbe held for the longterm rather than for stocks whose performance may depend on thebusiness cycle (potentially warranting trading at business cycle turning points) seemsfoundational: We're really onebalancesheetata time, onecompanyatatime kind ofinvestors,Mr.Poppe [comanagerof theSequoia fund]said inMay2008at theshareholdermeeting.Wedon'tspendalotoftimeonmacro.Today,thefocusisstillonbalancesheets,but the Sequoia managers try to minimize the impact of economic ups and downs on theportfolio. There'saheavierburdenonacyclicalcompany to find itsway into theportfolio,saysMr.Goldfarb [comanager of the Sequoia fund], as quoted in theWall Street Journal(2010).

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  • Table1.MutualFundSample:MediansbyYearThistableprovidesannualdescriptivestatisticsforthemutualfundsample.Medianvaluesforthevariablesarereportedforeachsampleyear.

    Year #ofFunds TNA ExpenseRatio #Stocks ActiveShareFund

    DurationFund

    TurnoverRatio

    FundHoldingTurnover

    1994 239 180 1.11% 69 86% 1.08 38% 1.291995 382 181 1.15% 72 85% 0.91 44% 1.581996 500 227 1.14% 75 84% 0.87 47% 1.581997 583 259 1.15% 72 84% 0.88 50% 1.511998 727 290 1.16% 71 82% 0.91 63% 1.591999 881 290 1.19% 70 79% 0.93 65% 1.662000 958 261 1.18% 71 76% 0.93 72% 1.642001 1,036 242 1.23% 73 74% 0.92 77% 1.442002 1,166 172 1.25% 74 73% 1.02 68% 1.362003 1,180 197 1.30% 77 75% 1.09 69% 1.472004 1,167 219 1.27% 76 78% 1.14 67% 1.422005 1,185 239 1.25% 75 79% 1.19 66% 1.422006 1,187 240 1.21% 74 80% 1.21 64% 1.432007 1,141 248 1.18% 72 80% 1.26 64% 1.372008 1,136 165 1.16% 73 78% 1.22 72% 1.402009 1,196 197 1.16% 80 79% 1.18 75% 1.472010 1,263 225 1.14% 76 78% 1.22 60% 1.342011 1,255 269 1.12% 73 79% 1.40 54% 1.232012 1,182 298 1.11% 71 79% 1.55 50% 1.152013 1,066 418 1.10% 74 80% 1.69 49% 1.15

  • Table2.MutualFundSample:DescriptiveStatisticsPanelAreportsthedescriptivestatisticsforthemutualfundsampleusedinthispaper.PanelBreportsthequintilecutoffsforActiveShareandthreevariablescapturingmutualfundtradingfrequency:FundDuration,FundTurnoverRatioandFundHoldingTurnover.PanelCpresents thecorrelationbetweenthemutual fundvariables.At theendofeachyear, fundsare firstsorted intoquintilesby theirFundDurationvalueandthenwithineachfunddurationquintilefurthersorted intoquintilesbasedontheirActiveShare. PanelD reports thepercentageofassets ineachof the25FundDuration/ActiveSharegroupsobtainedby sorting funds intoquintiles firstby theirFundDurationvalueand thenbyActiveSharevaluewithineachFundDurationquintile.PanelA

    Mean StDev. Min MaxActiveShare 77% 16% 20% 100%FundDuration 1.36 1.75 0.00 4.74FundTurnoverRatio 85% 80% 0% 2579%FundHoldingTurnover 162% 49% 0% 747%Log(TNA) 5.54 1.63 2.30 11.62ExpenseRatio 1.22% 0.42% 0.03% 5.32%#Stocks 117 195 10 3,450

    PanelB

    Q20 Q40 Q60 Q80ActiveShare 62% 74% 84% 92%FundDuration 0.65 0.99 1.38 2.00FundTurnoverRatio 27% 50% 77% 119%FundHoldingTurnover 83% 122% 164% 227%

    PanelC

    ActiveShare

    FundDuration

    FundTurnoverRatio

    FundHoldingTurnover Log(TNA)

    ExpenseRatio

    #Stocks

    ActiveShare 100% FundDuration 16% 100% FundTurnoverRatio 3% 70% 100% FundHoldingTurnover 7% 82% 78% 100% Log(TNA) 17% 20% 11% 12% 100% ExpenseRatio 29% 22% 16% 16% 32% 100% #Stocks 29% 8% 17% 11% 25% 16% 100%

  • PanelD

    ActiveShare Q1 Q2 Q3 Q4 Q5 Sum

    Fund

    Duratio

    n Q1 3.2% 2.4% 1.6% 1.4% 1.1% 9.7%Q2 3.7% 3.5% 2.6% 1.7% 1.2% 12.7%Q3 4.3% 3.9% 2.9% 2.4% 1.7% 15.2%Q4 6.0% 5.5% 3.8% 3.2% 2.4% 20.8%Q5 14.6% 9.8% 7.5% 5.8% 3.9% 41.6%

    Sum 31.8% 25.1% 18.4% 14.4% 10.3%

  • Table3.InstitutionalInvestors:SummaryStatisticsPanelAreportsthesummarystatisticsforActiveShareandFundDurationvariablesfortheinstitutionalinvestorsample.Thesampleperiodforinstitution investors is from1986 to2012except forHedgeFundswhere thesampleperiod is from1995 to2012due to fewer funds in theearlieryears.Ndenotesthenumberoffundyearobservations.FirstandSecondrowspresentthestatisticsforallinstitutionsandhedgefundsrespectively,remainingrowspresentthesummarystatisticsfordifferent institutional investortypesasdefined inBushee(2001).PanelBandPanelCpresents thenumberof institutionsand institutional investorassets ($billion) indifferentActiveSharegroups.PanelD reports thepercentageofinstitutionalinvestorassetsineachofthe25FundDuration/ActiveSharegroupsobtainedbysortingfundsintoquintilesfirstbytheirFundDurationvalueandthenbyActiveSharevaluewithineachFundDurationquintile.PanelA

    ActiveShare(%) FundDuration N Mean Stdev P20 Median P80 Mean Stdev P20 Median P80

    AllInstitutions 38769 72.60 19.48 56.29 74.80 91.61 1.42 0.85 0.64 1.34 2.16HedgeFunds 7713 83.90 15.38 72.33 89.20 96.61 0.92 0.74 0.27 0.74 1.50

    BNK 4828 55.1 13.9 45.0 54.7 65.7 1.97 0.69 1.40 1.98 2.56INS 1673 62.7 23.5 41.4 66.7 83.2 1.75 0.89 1.00 1.59 2.58INV 1353 70.5 19.6 55.4 73.5 88.4 1.45 0.70 0.88 1.34 2.04IIA 26265 77.0 16.6 62.7 79.3 92.9 1.28 0.78 0.57 1.19 1.94CPS 865 58.5 27.8 32.7 61.8 85.1 1.79 0.98 0.91 1.64 2.64PPS 410 33.5 23.9 12.4 23.8 60.9 2.21 0.79 1.53 2.30 2.88UFE 325 72.2 19.6 57.0 75.4 90.9 1.89 0.96 1.08 1.73 2.76

    OTHER 3050 78.4 18.7 60.6 83.3 96.4 1.25 1.11 0.14 1.02 2.26

  • PanelB

    NumberofInstitutionsActiveShare All HedgeFunds BNK INS INV IIA CPS PPS UFE MSC

    010 11 0 1 2 3 2 2 11020 26 1 5 4 8 8 12030 31 4 3 4 1 16 3 3 13040 43 7 10 7 3 14 3 4 24050 118 9 39 3 1 59 3 3 1 95060 281 33 52 4 7 189 5 2 226070 436 56 29 10 4 355 7 1 307080 462 112 19 7 6 388 4 2 368090 467 164 8 4 8 398 1 3 4590100 616 321 3 4 514 6 2 87Total 2491 707 168 44 36 1944 34 25 6 234

  • PanelC

    TotalAssets($billion)ActiveShare All HedgeFunds BNK INS INV IIA CPS PPS UFE MSC

    010 522.0 0.0 0.0 6.4 392.1 21.3 7.0 39.9 55.41020 1438.7 406.4 691.7 105.0 0.0 472.5 0.0 104.7 64.82030 137.4 29.5 7.8 23.1 10.0 57.5 3.5 20.7 14.83040 552.1 52.8 165.0 90.3 31.7 236.7 1.4 26.1 0.94050 1080.8 155.8 155.2 7.8 260.9 536.2 1.0 13.9 3.1 102.85060 1037.3 94.2 50.6 39.6 212.5 692.9 19.0 1.9 20.76070 555.6 106.9 27.6 21.2 51.9 429.2 5.8 5.0 14.97080 670.0 158.9 4.6 6.3 64.2 513.7 1.6 7.2 72.58090 396.9 127.8 1.9 7.5 18.8 319.8 0.2 0.0 11.4 37.490100 253.3 143.9 1.4 0.0 6.8 192.0 8.5 0.0 1.0 43.6Total 6644.3 1276.2 1105.9 307.2 1048.8 3471.7 48.0 219.4 15.5 427.7

    PanelD

    ActiveShare Q1 Q2 Q3 Q4 Q5

    F

    u

    n

    d

    D

    u

    r

    a

    t

    i

    o

    n

    Q1 3.7% 1.5% 1.0% 0.7% 0.3%Q2 6.5% 3.3% 1.8% 1.1% 0.5%Q3 12.9% 4.4% 2.9% 1.7% 0.8%Q4 16.0% 4.7% 2.4% 2.5% 1.2%Q5 20.5% 2.6% 2.6% 2.4% 2.1%

  • Table4.ActiveShareandFundDuration:MutualFundBenchmarkAdjustedNetReturnsThis table reports abnormal returns for mutual funds conditional on their Active Share and FundDuration.Fundsareassignedtooneofthe25portfoliosattheendofeachyearbysortingintoquintilesfirst based on Fund Duration and then further by Active Share within each Fund Duration quintile.Returnsare thencalculatedovernextoneyear.Panel A reports theequallyweighted5factoralphaobtainedastheinterceptfromtheregressionoftheaveragemonthlynetfundreturnsinexcessoftheirselfdeclaredbenchmarkonFamaandFrench3factors,theCarhartmomentumfactorandPastorandStambaughtradedliquidityfactor.Iftheselfdeclaredbenchmarkismissing,thenthebenchmarkindexwithminimumdeviation isassignedas that fundsbenchmark.The first row reports the returns for5portfoliosobtainedbysortingfundsunconditionally intoquintilesbytheirActiveShare. Similarly,thefirstcolumnreportsalphasforportfoliosobtainedbysortingunconditionallyonFundDurationmeasure.RestofthePanelpresentreturnsforportfoliosobtainedbysortingbothonFundDurationandthenonActiveShare.PanelBpresentsthevalueweighted5factoralphas.PanelC,PanelDreporttheaveragevalueweightedandequalweightednetfundreturnsinexcessofthebenchmarkindex.PanelA

    EqualWeighted5FactorAlphaofBenchmarkAdjustedNetReturns

    ActiveShare

    FundDuration Uncond. 1 2 3 4 5 51Uncond. 0.98 1.45 1.44 0.84 0.25 1.22

    (4.49) (3.97) (3.64) (1.74) (0.45) (2.47) 1 1.96 2.46 2.00 1.64 1.75 1.94 0.44 (3.87) (5.52) (4.01) (2.57) (2.13) (2.45) (0.57)2 1.20 1.46 1.84 1.70 0.67 0.34 1.09 (3.20) (4.39) (3.84) (3.37) (1.20) (0.50) (1.64)3 0.96 1.52 1.14 1.54 0.31 0.27 1.20 (2.39) (5.39) (2.47) (3.33) (0.49) (0.37) (1.74)4 0.67 0.91 1.48 1.06 0.55 0.65 1.69 (1.96) (3.17) (3.94) (1.20) (1.07) (1.08) (2.89)5 0.37 1.06 1.11 1.54 0.44 2.30 3.47 (0.98) (4.44) (2.84) (3.09) (0.75) (3.14) (4.78)

    51 1.68 1.28 0.89 0.39 1.52 4.32 (3.46) (2.99) (1.83) (0.57) (1.80) (5.18)

  • PanelB

    ValueWeighted5FactorAlphaofBenchmarkAdjustedNetReturns

    ActiveShare

    FundDuration Uncond. 1 2 3 4 5 51Uncond. 0.98 1.45 1.44 0.84 0.25 1.22

    (4.49) (3.97) (3.64) (1.74) (0.45) (2.47)1 2.52 1.64 2.39 3.85 3.59 3.35 1.55 (3.31) (2.46) (3.39) (4.47) (2.67) (2.11) (1.03)2 1.49 1.36 1.75 2.14 1.31 1.66 0.21 (2.79) (2.39) (2.36) (3.13) (1.58) (1.41) (0.17)3 0.78 2.10 0.68 1.10 0.58 0.40 1.50 (1.26) (4.29) (0.80) (1.49) (0.67) (0.42) (1.52)4 0.68 0.48 0.78 1.48 1.63 0.71 0.41 (1.25) (0.95) (1.36) (1.58) (2.30) (0.48) (0.27)5 0.04 0.27 1.34 0.30 0.73 1.85 2.57 (0.09) (0.60) (2.30) (0.38) (0.83) (1.88) (2.57)

    51 2.30 1.10 0.97 3.46 2.76 5.22 (3.15) (1.52) (1.22) (3.64) (2.20) (3.15)

    PanelC

    EqualWeightedBenchmarkAdjustedNetReturn

    ActiveShare

    FundDuration Uncond. 1 2 3 4 5 51Uncond. 0.92 0.97 1.06 0.49 0.05 0.96

    (3.30) (2.40) (2.26) (1.01) (0.08) (1.83) 1 1.15 1.60 0.97 0.92 1.09 1.22 0.37 (1.67) (2.76) (1.53) (1.02) (1.12) (1.31) (0.45)2 0.81 0.83 1.34 1.22 0.42 0.26 0.58 (1.87) (2.22) (2.66) (2.09) (0.73) (0.35) (0.84)3 0.57 0.90 0.61 1.01 0.27 0.60 0.29 (1.40) (3.19) (1.24) (2.06) (0.46) (0.81) (0.40)4 0.48 0.36 1.19 0.84 0.58 0.56 0.93 (1.39) (1.39) (2.89) (0.73) (1.07) (0.90) (1.42)5 0.38 0.90 0.75 1.33 0.65 1.92 2.66 (0.79) (4.40) (1.85) (2.21) (0.90) (2.08) (3.09)

    51 0.78 0.69 0.22 0.42 0.44 2.98 (0.92) (1.28) (0.35) (0.38) (0.35) (2.31)

  • PanelD

    ValueWeightedBenchmarkAdjustedNetReturn

    ActiveShare

    FundDuration Uncond. 1 2 3 4 5 51Uncond. 0.16 0.43 0.70 0.44 0.54 0.38 (0.37) (0.74) (1.19) (0.61) (0.63) (0.42)

    1 1.40 0.60 1.74 2.30 1.98 1.70 1.11 (1.60) (0.75) (2.18) (2.13) (1.36) (1.10) (0.76)2 0.82 0.59 0.66 1.68 0.88 1.57 0.98 (1.18) (1.00) (0.71) (2.13) (0.99) (1.21) (0.76)3 0.24 0.88 0.53 0.84 0.56 0.76 0.12 (0.38) (1.56) (0.64) (1.09) (0.71) (0.63) (0.10)4 0.58 0.58 0.40 1.32 1.07 0.52 0.07 (0.93) (1.18) (0.56) (0.99) (1.61) (0.31) (0.04)5 0.25 0.02 0.38 0.15 0.89 1.66 1.67 (0.42) (0.04) (0.62) (0.18) (1.00) (1.53) (1.53)

    51 1.66 0.58 1.36 2.46 1.08 3.36 (1.79) (0.71) (1.51) (2.03) (0.70) (1.91)

  • Table5.FundTurnoverandActiveShare:5FactorAlphaofBenchmarkAdjustedNetReturnsThistablereportstheaverageabnormalmutualfundreturnsconditionalonFundTurnoverandActiveShare. Average equally weighted returns for quintile portfolios obtained by sorting funds either onActiveShareoronTurnoverarepresentedinfirstrowandcolumnrespectively.Averagereturnsfor25portfoliosobtainedbysorting funds intoquintiles firstonTurnoverandthenonActiveSharearealsoreported.PanelAreportstheabnormalreturnsconditionalon fundsselfreportedturnoverratioandActiveShare.PanelBpresentsreturnsconditionalonfundsaveragequarterlyturnoverratiocalculatedfromchangesinfundsholdingsoverlast4quartersusingthemethodologyinGaspar,MassaandMatos(2005).Allthereturnsareinyearlypercentages.Significanceatthe5%levelisdenotedinbold,andtstatisticsaregiveninparentheses.PanelA

    EqualWeighted5FactorAlphaofBenchmarkAdjustedNetReturns

    ActiveShare

    FundTurnoverRatio Uncond. 1 2 3 4 5 51

    Uncond. 0.98 1.45 1.44 0.84 0.25 1.22 (4.49) (3.97) (3.64) (1.74) (0.45) (2.47)

    1 0.38 0.42 0.98 0.91 0.47 0.90 1.32 (1.05) (1.77) (2.82) (1.95) (0.91) (1.15) (1.63)2 0.47 0.61 1.31 0.86 0.62 1.07 1.68 (1.40) (2.44) (3.22) (2.05) (1.15) (1.82) (3.10)3 0.61 0.91 1.25 1.50 0.01 0.62 1.52 (1.62) (3.10) (2.86) (2.90) (0.02) (0.94) (2.50)4 1.43 1.85 1.57 2.20 1.17 0.35 1.50 (3.86) (6.05) (3.58) (1.15) (1.99) (0.54) (2.24)5 1.58 1.48 1.40 2.08 1.28 1.66 0.17 (2.81) (3.41) (2.18) (3.30) (1.60) (1.92) (0.22)

    51 1.20 1.06 0.42 1.17 0.81 2.56 (2.34) (2.44) (0.70) (1.73) (1.00) (2.75)

  • PanelB

    EqualWeighted5FactorAlphaofBenchmarkAdjustedNetReturns

    ActiveShare

    FundHoldingsTurnover Uncond. 1 2 3 4 5 51Uncond. 0.98 1.45 1.44 0.84 0.25 1.22

    (4.49) (3.97) (3.64) (1.74) (0.45) (2.47) 1 0.14 0.24 0.73 1.01 0.14 1.44 1.68 (0.39) (1.10) (2.19) (2.14) (0.27) (1.91) (2.28)2 0.51 0.82 0.97 0.98 0.63 0.83 1.66 (1.49) (2.88) (2.46) (2.04) (1.33) (1.42) (2.77)3 0.64 1.28 1.37 1.44 0.12 1.02 2.30 (1.61) (4.18) (3.00) (3.00) (0.20) (1.45) (3.55)4 1.21 1.38 1.57 1.82 1.08 0.20 1.18 (2.89) (4.32) (3.23) (1.33) (1.89) (0.25) (1.50)5 1.97 1.74 1.86 2.21 2.05 1.99 0.25 (4.29) (4.77) (3.63) (3.85) (2.64) (2.68) (0.35)

    51 1.84 1.50 1.14 1.19 1.91 3.43 (3.82) (4.28) (2.34) (1.94) (2.34) (3.52)

  • Table6.MutualFundActiveShareandFundDuration:RegressionEvidenceThis


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