Style Rotation and Performance Persistence of Mutual Funds

Most academic studies on performance persistence in monthly mutual fund returns do not find evidence for timing skills of fund managers. Furthermore, realized returns are undoubtedly driven by the investment style of a fund. We propose a new holdings-based measure of style rotation to investigate the relation between performance persistence and changes in style. For a large sample of U.S. domestic equity mutual funds we find that top and bottom performing decile portfolios, sorted on past one-year returns and risk-adjusted excess performance from a 4 factor model, exhibit a higher degree of style rotation than middle deciles. Style inconsistent funds also more frequently switch between top and bottom performance deciles over subsequent years. Hence, it is important for delegated portfolio management to consider style rotation when selecting managers based on past performance