Mutual fund performance and changes in factor exposure

In this article, we examine whether active mutual funds that markedly change their exposure to systematic risk factors subsequently outperform. We propose a new returns‐based approach to assess the degree to which mutual funds adjust their risk exposure, with the benefit of not requiring periodically updated information related to funds' portfolio holdings. Applying this measure to active US mutual funds from 1990 to 2016, we provide evidence that mutual fund managers exhibiting substantial changes in their risk exposure generate alphas that are significantly higher than those with limited exposure variation. Other characteristics such as fund tracking errors, fund size, and investment style, or holdings‐based measures cannot explain these findings. Analyzing the long‐term persistence of active management, we provide evidence that the outperformance is due to managers' skill rather than to luck. Our findings contribute to the empirical evidence suggesting that active management may in some cases, produce short‐term performance persistence.