Market timing and the determinants of performance of sector funds over the business cycle

Purpose – Market‐timing skills of fund managers are an important issue for both mutual fund investors and researchers. The purpose of this paper is to analyze the market‐timing skills and determinants of performance of sector funds across business cycles to see whether sector fund managers exhibit different market‐timing abilities across business cycle. Design/methodology/approach – Single factor, five‐factor conditional and five‐factor unconditional models were used to estimate the initial results for market timing of sector funds across the business cycle. Monthly data such as returns, Fama and French factors, and fund specific variables of sector funds from January 1990 to December 2005 were used to estimate initial and cross‐sectional results. Cross‐sectional analyses were done using two approaches: the traditional approach where alpha, the dependent variable, is estimated assuming that betas of predicting variables remain constant over time, and where alpha is estimated assuming that betas do change over time. Estimated alpha was estimated as a function of fund specific variables to examine which fund specific variables influence fund abnormal performance across the overall, recessionary, and expansionary periods. Findings – The benchmark used in the analysis (S&P vs sector specific) was shown to greatly influence the results. Sector funds demonstrate positive timing ability during recessions and negative timing ability during expansions when using the S&P 500 as the benchmark, but this timing ability disappears when sector specific benchmarks are used. As a whole, sector funds exhibit significant negative timing ability across all stages of the business cycle. When using the more appropriate industry specific benchmarks, only the utility sector demonstrates significant timing ability over both stages of the business cycle. Research limitations/implications – Only two recessions are observed over the period of study. More recession periods would have given a clearer picture of findings across business cycle. Practical implications – This paper offers readers an insight into the market‐timing abilities of sector fund managers across the business cycles. Investors can use the findings of this paper to develop hedging strategies especially when the economy is going through recession. Originality/value – This paper covers the longest period of sector funds market timing and is the only one that evaluates sector funds across business cycle.