Do sophisticated investors follow fundamental analysis strategies? Evidence from hedge funds and mutual funds

Using fund returns and fund stockholdings, we investigate whether fund managers follow fundamental analysis strategies. We show that hedge fund and mutual fund returns tend to load negatively on the long-short returns of a comprehensive sample of fundamental strategies (i.e., accounting anomalies), suggesting that fund managers are prone to trade in the opposite direction of what fundamental strategies prescribe. The negative loadings are primarily driven by the short-leg of the anomalies, more pronounced for contrarian-like anomalies, and more prevalent among earnings quality, investment, external financing, value, and profitability-based anomalies. We show that funds with higher anomaly loadings perform significantly better. Our results suggest that fund managers, as a group, do not systematically pursue fundamental analysis strategies, perhaps due to agency concerns, but a subset of managers are skilled and profit from employing such strategies. We find similar results when examining the stockholdings of hedge funds and mutual funds. Our findings have important implications for the persistence of accounting anomalies, sophistication of institutional investors, and investment value of fundamental analysis.