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Skill and Efficiency in the U.S. Mutual Fund Industry

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Abstract

We propose a new measure of mutual fund manager ability: "efficiency" is the ability to accrue the risk premium associated with a risk factor. The familiar abnormal return, or alpha, is shown to be the sum of two distinct measures of ability: "aggregate efficiency" which is the beta-weighted sum of the fund's (in)efficiencies across risk factors, and "skill," the component that is unrelated to factor exposures. Using a panel of U.S. equity mutual fund returns from 1999-2023, we document significant heterogeneity in mutual fund manager skill and efficiency. We employ regression trees and their extensions to capture this heterogeneity. We find that efficiency is more persistent than skill, and we show that future abnormal returns can be better predicted by decomposing lagged abnormal returns into skill and efficiency.

Suggested Citation

  • Dong Hwan Oh & Andrew J. Patton, 2026. "Skill and Efficiency in the U.S. Mutual Fund Industry," Finance and Economics Discussion Series 2026-032, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:103342
    DOI: 10.17016/FEDS.2026.032
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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