Skill, scale, and value creation in the mutual fund industry

When investors shop for mutual funds, they typically focus on performance, which is generally measured by the level of returns (compared to a given benchmark). However, far less is known about value creation, i.e. whether funds, or rather the fund managers, are capable of extracting genuine value from capital markets through their investment decisions. Moreover, when investors make their decision, they seldom manage to consider the ability to identify profitable investment ideas (skill) and to manage the fund's growth over time (scalability), limiting themselves to the traditional measures of size and performance. An empirical study performed by researchers at the Swiss Finance Institute in Lugano and Geneva and at McGill University in Canada, and published in the world-leading Journal of Finance, has identified an alternative approach to fund value creation that focuses on the ability to identify profitable investment ideas (skill) and to grow in size (scalability). Co-author Patrick Gagliardini , Full professor of Econometrics at the USI Institute of Finance, tells us more. Active funds create value when they trade based on superior information (stock picking, factor timing, etc.), or when they provide liquidity to absorb selling pressure during downtrend phases. In their study, Prof. Gagliardini, Olivier Scaillet (University of Geneva) and Laurent Barras (McGill University), propose an alternative breakdown of the value added in an investment fund.