On Persistence in Mutual Fund Performance
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What they found
Carhart asked whether mutual funds with good past returns keep winning. Using a survivorship-free database of U.S. equity funds from 1962 to 1993, he found that almost all short-term persistence in fund returns is explained by the funds happening to hold last year's momentum stocks, plus differences in fees and costs. To show this he added a momentum factor to the Fama-French three-factor model, creating the four-factor model that is now the standard benchmark for judging active managers.
What you can use
- 'Hot' funds are usually just riding momentum, not exhibiting skill; the effect fades within a year.
- The one reliable form of persistence is at the bottom: bad funds stay bad, mostly because of high fees.
- If you evaluate any strategy or manager, compare it to a benchmark that includes momentum, or you will mistake momentum exposure for alpha.
Caveats
Mutual funds only, pre-1994. The momentum factor is constructed to fit fund data and is not itself a tradable product.
Tags: momentum, mutual-funds, factor-model, persistence
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.