41 Pages Posted: 17 Feb 2017Date Written: February 17, 2017
AbstractI investigate the skill of mutual fund managers by focusing in their holdings of a special type of stock. Kumar (2009) classifies low price, high idiosyncratic risk and skewness stocks as ‘Lottery Stocks’, and shows that these securities severely under-perform. I look at the effect that these investments have on the performance of U.S. equity mutual funds, and how they reflect on the skill of the manager. As part of this analysis I introduce the ‘Lottery Score’, the percentage of equity assets invested in Lottery Stocks. I find that the Lottery Stocks that fund managers pick tend to outperform the rest of the market, and the funds themselves persistently outperform similar funds that don’t invest in these stocks. An investable strategy that buys Lottery Stocks held by the funds and sells those ignored by them attains a monthly alpha of 2%. The Lottery Score is shown to be a good predictor of fund performance, even after controlling for a number of previously introduced measures of skill. Since the funds’ out-performance cannot be fully explained by their allocation to Lottery Stocks, this behavior uncovers a more general ability for asset management.
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