Hot Hands in Mutual Funds: The Persistence of Performance, 1974-87

Abstract

The net returns of no-load mutual gro'Mh funds exhibit a hot-hands phenomenon during 1974-87.When performance is measured byJensen's alpha, mutual funds that perform well in a one year evaluation period continue to generate superior performance in the following year.Underperformers also display short-run persistence.Hot hands persists in 1988 and 1989.The success of the hot hands strategy does not derive from selecting superior funds over the sample period.The timingcomponent -knowing when to pick which fund -is sigeificant.These results are robust to alternative equity portfolio benchmarks, such as those that account for firm-size effects and mean reversion in returns.Capiti'ing on the hot hands phenomenon, an investor could have generated a significant, risk-adjusted excess return of 10% per year.

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