The role of passive effects in the relationship between active management and short-term performance: Evidence from mutual fund portfolio holdings

This study proposes a new method to measure active management in a given quarter based on the correlation between fund returns and the returns of a passively-managed synthetic portfolio emulating fund portfolio holdings. A lower level of correlation indicates higher levels of active management since the behaviour of actual fund daily returns deviates to a greater extent from those that the fund would have obtained in the case of no trading activity. Abnormal fund performance is measured as the difference between fund and synthetic portfolio alphas to distinguish the value added by active management during a quarter from that obtained passively by fund holdings. Thus, each synthetic portfolio serves as an endogenous benchmark to assess active management and performance of the fund it emulates, while avoiding biases due to passive effects. In line with previous literature, the aggregate abnormal performance is negative. Moreover, results suggest that active management due to stock trading activity is lower in more volatile periods, and relates negatively to abnormal fund performance in the short-term.