Mutual Fund Style, Characteristic-Matched Performance Benchmarks and Activity Measures: A New Approach

We propose a new approach for measuring mutual fund style and constructing characteristic-matched performance benchmarks that requires only portfolio holdings and two reference portfolios in each style dimension. The characteristic-matched performance benchmark literature typically follows a bottom-up approach by first matching individual stocks with benchmarks and then obtaining a portfolio’s excess return as a weighted average of the excess returns on each of its constituent stocks. Our approach is fundamentally different in that it matches portfolios and benchmarks directly. We illustrate our approach using portfolio holdings of 1183 fund managers over the period 2002-2009. We characterize the cross-section of fund manager styles and show how average style changes over time. The tracking error volatilities of our characteristic-matched benchmarks compare favorably with those of existing methods. Using our benchmarks we explore the link between activity and performance.