What Are the Effects of Security Selection and Market Timing on Mutual Fund Performance? A Study of Portfolio Returns and Manager Activity in Sweden

Abstract: We study the activity of Swedish equity mutual funds by splitting fund manager activity into two different components: market timing and security selection. This is done through a decomposition of the Tracking Error, a method that requires data of the portfolio and index returns exclusively. No portfolio holdings data is needed. We identify with high statistical significance that market timing has a negative correlation with future performance for the funds in our sample, both for the large cap and small/mid cap group. For security selection we see no clear effect on future performance for the large cap funds, but a positive effect for the small/mid cap funds. Furthermore, we find with high statistical significance that fund managers are loyal to their strategies, as there is a strong persistence in stock picking and market timing over time. The results we find are mostly in line with a similar study conducted on the U.S. market, as well as other studies regarding the relationship between fund activity and alpha on the Swedish market.