Mutual Fund Trades: Timing Sentiment and Managing Tracking Error Variance
58 Pages Posted: 19 Aug 2012
Date Written: August 18, 2012
We use portfolio holdings to show that mutual funds preferentially trade stocks according to the stocks’ sentiment betas. Stocks with high sentiment betas are more responsive to investor sentiment and increase (decrease) in value as sentiment increases (decreases). Sentiment-based trades may be motivated by the opportunity to increase fund returns through timing predictability in sentiment, or by management of portfolio risk. Sentiment is mean-reverting, but its level and recent change only partially explain these trades. In contrast, 30 percent of sentiment-based trades are explained by the initial sentiment beta of funds that trade to reduce their tracking error variance.
Keywords: Sentiment betas, tracking error variance
JEL Classification: C13, G12, G20
Suggested Citation: Suggested Citation