Information Content When Mutual Funds Deviate from Benchmarks

The consensus wisdom of active mutual fund managers, as reflected in their average over- and underweighting decisions, contains valuable information about future stock returns. Analyzing a comprehensive sample of active U.S. equity funds 1984-2008, we find that stocks heavily overweighted by active funds outperform their underweighted counterparts by more than 7% per year, after adjustments for their loadings on the market, size, value, and momentum factors. This large premium dissipates quickly as the consensus view becomes publicly available. These results are consistent with the notion that informed investing by active mutual funds enhances the informativeness of stock prices. In addition, active mutual funds invest only a small portion of fund assets in high alpha stocks, in accordance with the consensus view that active mutual funds on average fail to outperform passive benchmarks