Management Science Review

The high returns from buying stocks that are past winners and selling past losers represents one of the most prominent and studied puzzles in finance. “Momentum,” as it is frequently called, is simple to implement and popular, particularly among mutual funds. Momentum has been shown to account for almost all of the stock-picking ability of mutual fund managers.

Yet little evidence exists on whether momentum trading is also favored by what many regard as the most sophisticated and incentivized managers: those who run the three trillion dollar hedge fund industry. To address this question, this study develops the most comprehensive to date database of the quarterly stock positions of 589 mutual fund, 1,342 hedge fund, and 2,894 other institutional fund managers, with mutual fund managers alone overseeing more than 2,600 mutual funds.

The study reveals that hedge fund strategies are mostly contrarian. The 2/3 of hedge fund managers that are contrarian are the only institutional outperformers, earning alpha of 2.4% per year, with two-thirds of this performance coming from the purchases of stocks. Contrarian hedge fund managers’ success derives from their superior stock-picking skills—the ability to pick the right past losers among stocks with similar characteristics. Stocks that are purchased by contrarian hedge fund advisers outperform other stocks with similar characteristics by 2.7% per year and outperform the stocks sold by these advisers by an average annual alpha of 3.4%.

The superior contrarian hedge fund performance is persistent and so is their trading style, providing investors a useful signal when picking hedge fund managers. About 80% of hedge fund managers that are contrarian in the first half of the sample period are also contrarian in

the second half. Mutual fund managers’ momentum investment style is equally persistent.

Contrarian hedge fund managers tend to trade profitably with all other manager types, especially when purchasing stocks from momentum-oriented hedge fund and mutual fund managers. In this case, the former managers earn alphas of 4.2% per year. When trading alongside contrarian hedge fund advisers, the adviser is always better off when agreeing on a stock’s trade direction (buy vs. sell) with contrarian hedge funds than when disagreeing.

These results are further reinforced by the analysis of aggregate short positions. Selling stocks that contrarian hedge fund managers purchase is a particularly perilous strategy for stocks with below-median short interest, which are among the most profitable trades of contrarian hedge fund advisers. Purchases of stocks with below-median levels of short interest earn contrarian hedge fund advisers alphas of 5.4% per year, while for above-median short interest the comparable average stock alpha is 2.5% per year. To the extent that short interest in a stock is representative of hedge fund positions, greater short interest contributes positively to the performance of hedge funds observed from their long positions. Overall, these findings show that contrarian hedge fund advisers exhibit superior stock-picking ability that goes beyond a naïve style-based strategy or liquidity provision.

Read the full article:


Grinblatt M, Jostova G, Petrasek L, and Philipov A (2020).  Style and Skill: Hedge Funds, Mutual Funds, and Momentum. Management Science 66, 5505– 5531.

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