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Feb 15

Mutual Fund's R2 as Predictor of Performance

Posted by abiao at 14:16 | Paper Review | Comments(1) | Reads(8771)
Improving the accuracy of mutual funds' performance prediction is an interesting and endless topic. A paper published in Review of Financial Studies by Amihud and Goyenko (2013) No. 26 (3) investigates this issue at a new angle: Lower R2 indicates greater selectivity, and it significantly predicts better performance. Nice.

We propose that fund performance can be predicted by its R2, obtained from a regression of its returns on a multifactor benchmark model. Lower R2 indicates greater selectivity, and it significantly predicts better performance. Stock funds sorted into lowest-quintile lagged R2 and highest-quintile lagged alpha produce significant annual alpha of 3.8%. Across funds, R2 is positively associated with fund size and negatively associated with its expenses and manager's tenure.


Journal paper, Working paper.


It seems a lot of financial statistical metrics rely quite heavily on correlation. As useful as this is, correlation helps establish a relationship between variables, but not the cause for one or the other variables change.

As with other metrics such as internal rate of return or IRR, additional factors that influence price movement and valuation are also quite relevant in evaluating a mutual funds performance.
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