Market Timing : A Decomposition of Mutual Fund Returns

We decompose the conditional expected mutual fund return in five parts. Two parts, selectivityand expert market timing, can be attributed to manager skill, and three to variation in marketexposure that can be achieved by private investors as well. The dynamic model that we use toestimate the relative importance of the components in the decomposition is a generalization ofthe performance evaluation models by Lockwood and Kadiyala (1988) and Ferson and Schadt(1996). We find that the restrictions imposed in existing models may lead to different inferencesabout manager selectivity and timing skill. The results from our sample of 78 asset allocationmutual funds indicate that several funds exhibit significant expert market timing, but for mostfunds variation in market exposures does not yield any economically significant return. Fundswith high turnover and expense ratios are associated with managers with better skills