Conditional Performance, Portfolio Rebalancing, and Momentum of Small-Cap Mutual Funds

Posted: 12 Dec 2002

See all articles by Larry R. Gorman

Larry R. Gorman

California Polytechnic State University


To assess the performance of small-cap stocks net of transaction costs, we analyze 165 actively managed small-cap oriented portfolios. Our analysis addresses three areas of interest, (i) performance net of transaction costs, (ii) the magnitude of trading costs incurred when rebalancing an actively managed portfolio, and (iii) the potential for momentum strategy profits when investing in small-cap stocks. Using conditional estimation we find that small-cap funds have earned a significantly positive abnormal return of about 2 percent per year in the period January 1986 to December 2000. We also estimate the cost of January rebalancing to be 0.4 percent of portfolio value, a value that is significant for over 20 percent of the portfolios under study. Finally, after trading frictions are taken into account, we find evidence that small-cap portfolios exhibit significant return patterns, similar in nature to momentum patterns initially documented in a frictionless setting by Jegadeesh and Titman (1993, 2001). Our findings support recent behavioral models which attempt to explain these patterns. Consistent with the findings of Jegadeesh and Titman, we find that past "winners" continue to outperform in the next 12 months, followed by a performance reversal.

Keywords: Size effect, conditional estimation, frictions, momentum, mutual funds, investments, stock market, stocks

JEL Classification: G11, G12

Suggested Citation

Gorman, Larry, Conditional Performance, Portfolio Rebalancing, and Momentum of Small-Cap Mutual Funds. Available at SSRN:

Larry Gorman (Contact Author)

California Polytechnic State University ( email )

College of Business
Department of Finance
San Luis Obispo, CA 93407
United States
805-756-1312 (Phone)
805-756-1473 (Fax)

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