Implied Cost of Capital and Mutual Fund Performance

Which trading strategies differentiate skilled mutual fund managers from their unsuccessful peers? This study provides evidence for a positive association between holdings' implied cost of capital (ICC) and future fund performance. Consistent with large transaction costs of ICC-based investments impeding their exploitation, family-level trading efficiency positively correlates with fund-level ICC. A negative association between ICCs and mid-year risk shifting corroborates the notion of fund managers decisively choosing and relying on high-ICC strategies. Institutional investors able to identify funds with high ICCs direct their investments accordingly, whereas flows of retail funds are unaffected, consistent with limited investor attention and financial literacy