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Portfolio Quality and Mutual Fund Performance

Authors

  • David R. Gallagher,

    1. Macquarie Graduate School of Management, Sydney, NSW, Australia
    2. Capital Markets CRC Limited, Sydney, NSW, Australia
    3. Centre for International Finance and Regulation, Sydney, NSW, Australia
    4. Australian School of Business, The University of New South Wales, Sydney, NSW, Australia
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  • Peter A. Gardner,

    1. Plato Investment Management, Sydney, NSW, Australia
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  • Camille H. Schmidt,

    Corresponding author
    1. Macquarie Graduate School of Management, Sydney, NSW, Australia
    2. Capital Markets CRC Limited, Sydney, NSW, Australia
    3. Centre for International Finance and Regulation, Sydney, NSW, Australia
    • Camille H. Schmidt

      Macquarie Graduate School of Management

      Sydney

      NSW 2109

      Australia

      cschmidt@cmcrc.com

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  • Terry S. Walter

    1. Discipline of Finance, The University of Sydney Business School, Sydney, NSW, Australia
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  • The authors gratefully acknowledge invaluable comments provided by an anonymous referee, Yaowen Shan, Stephen Taylor, Nick White, Andrew Ferguson, Jeff Coulton, and seminar participants at the University of Technology, Sydney and Macquarie University. The authors are also appreciative of the generous financial support provided by the Capital Markets Co-operative Research Centre and Mercer Investments.

Abstract

This study investigates how the quality of stocks owned by mutual funds affects the performance of those funds during 2000–2009. The quality of a stock is positively related to its size, while quality is inversely related to volatility. Evidently, stocks in the lowest quality decile perform particularly poorly amidst volatile market conditions with a mean monthly Daniel, Grinblatt, Titman and Wermers (DGTW) alpha 1.93% [25.73% per annum (pa)] less than high-quality stocks. Furthermore, funds which hold the lowest quality stocks exhibit substantial underperformance, particularly during market downturns, with funds in the lowest decile of quality incurring a mean monthly DGTW alpha 0.96% (12.14% pa) lower than their higher quality counterparts. Interestingly, we discover a trend to funds investing in higher quality stocks over time.

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