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Machine learning and fund characteristics help to select mutual funds with positive alpha

Author

Listed:
  • DeMiguel, Victor
  • Gil-Bazo, Javier
  • Nogales, Francisco J.
  • Santos, André A.P.

Abstract

Machine-learning methods exploit fund characteristics to select tradable long-only portfolios of mutual funds that earn significant out-of-sample annual alphas of 2.4% net of all costs. The methods unveil interactions in the relation between fund characteristics and future performance. For instance, past performance is a particularly strong predictor of future performance for more active funds. Machine learning identifies managers whose skill is not sufficiently offset by diseconomies of scale, consistent with informational frictions preventing investors from identifying the outperforming funds. Our findings demonstrate that investors can benefit from active management, but only if they have access to sophisticated prediction methods.

Suggested Citation

  • DeMiguel, Victor & Gil-Bazo, Javier & Nogales, Francisco J. & Santos, André A.P., 2023. "Machine learning and fund characteristics help to select mutual funds with positive alpha," Journal of Financial Economics, Elsevier, vol. 150(3).
    • Handle: RePEc:eee:jfinec:v:150:y:2023:i:3:s0304405x23001770
    DOI: 10.1016/j.jfineco.2023.103737
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    Cited by:

    1. Kaniel, Ron & Lin, Zihan & Pelger, Markus & Van Nieuwerburgh, Stijn, 2023. "Machine-learning the skill of mutual fund managers," Journal of Financial Economics, Elsevier, vol. 150(1), pages 94-138.

    More about this item

    Keywords

    Active asset management; Mutual-fund performance; Mutual-fund misallocation; Machine learning; Tradable strategies; Nonlinearities and interactions;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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