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Introduction
There exists a large body of academic literature on the ability of mutual fund managers to time the equity market. Overall, there is little evidence in favour of positive market timing ability. A notable exception is Bollen and Busse (2001), who find positive market timing based on daily instead of monthly mutual fund returns. We extend their research by investigating investment style timing based on daily data.
Mutual fund managers might provide their investors with additional returns by increasing and decreasing their exposure to the equity market when the market goes up or down. Mutual funds might enhance their value for investors by increasing or decreasing their exposure to certain investment styles. Barberis and Shleifer (2003) claim that herd behaviour among investors might explain the existence of these investment styles. Mutual fund managers could benefit from this documented herding behaviour. In the literature, three investment styles are often distinguished: size, value, and momentum. Mutual fund managers who are able to predict these factors may end up with economically significant profits; see, for example, Levis and Liodakis (1999). The size and value styles are both recognised to be important for private investors by Morningstar, as their equity style box classification relies on these two dimensions.
Our findings on market timing strengthen the evidence of Bollen and Busse (2001) in favour of market timing ability. We extend their performance analysis by also investigating style timing ability on size, valuation, and momentum. Our empirical results suggest that mutual funds are able to time the direction of the valuation and momentum style. We find no evidence on timing ability between small and large capitalisation stocks.
The remainder of this paper is organised as follows. In the following section, we describe the methods used to investigate timing ability of mutual fund managers. Then, we describe the data and report the results from our performance evaluation study in the succeeding section. The final section concludes our analysis.
Methods to investigate timing ability
In the existing mutual fund market timing literature, two performance evaluation models are widely used: the Treynor and Mazuy (1966) model (TM model) and Henriksson and Merton (1981) model (HM model). These models evaluate the relation between a mutual fund portfolio's sensitivity coefficient to the market portfolio...