Mutual Fund's R2 as Predictor of Performance

Abstract

Abstract:We propose that fund performance is predicted by its R 2 , obtained by regressing its return on the Fama-French-Carhart four benchmark portfolios. Lower R 2 , or higher idiosyncratic risk relative to total risk, measures selectivity or active management. We show that lagged R 2 has significant negative predictive coefficient in predicting alpha or Information Ratio. This is consistent with Cremers and Petajisto's (2008) results on the effect of selectivity. Funds ranked into lagged lowest-quintile R 2 and highest-quintile alpha produce significant alpha of 2.8%. Also, both fund RMSE and return volatility predict the following year's performance with significant positive and negative coefficients, respectively. Across funds, R 2 is an increasing function of fund size and a decreasing function of its age, its manager tenure and its past performance, but better performance induces funds to subsequently increase their R 2 .

Predictive power of Brazilian equity fund performance using R2 as a measure of selectivity

“…Finally, also using regression models, the main determinants of the R 2 of the funds were calculated, by investigating the explanatory power of characteristics such as time under current management, size, age, expenses, turnover, and style. Th e results from Amihud and Goyenko (2013) confi rm these relationships and allow it to be concluded that there is eff ectiveness in the methodology. Th e portfolio of funds with the lowest R 2 and highest performance presented signifi cantly better returns than those of the other portfolios.…”

“…This study is based on the methodology created by Amihud and Goyenko (2013) for predicting fund performance based on level of selectivity. Th e methodology supports the hypothesis that the greater a fund's level of activity is, the better its performance will be.…”

“…In order to avoid using a model based on a spurious relationship, Amihud and Goyenko (2013) compared their methodology with other methods of evaluating fund selectivity that use the compositions of fund portfolios as information. One of these methodologies is represented by the characteristic selectivity indicator from Daniel et al (1997).…”

“…Th is study aims to apply, for the fi rst time ever in the Brazilian market (as far as we know), the methodology from Amihud and Goyenko (2013), authors who investigated the eff ectiveness of one method for selecting US equity funds based on their levels of activity or selectivity, under the hypothesis that greater activity would generate greater returns.…”

“…Th is therefore concerns a method that requires normally available information in order to facilitate its application. Amihud and Goyenko (2013) analyzed the monthly returns of 2,460 funds with equity of at least 15 million dollars, covering 1988 to 2010. Th e moving window for calculating the R 2 and performance was 24 months.…”