The literature assessing whether mutual fund managers have skill typically regards market timing or stock picking skills as immutable attributes of a manager or fund. Yet, measures of these skills appear to vary over the business cycle. This paper offers a rational explanation, arguing that timing and picking are tasks. A skilled manager can choose how much of each task to attend to. Using tools from the rational inattention literature, we show that in booms, a manger should pick stocks and in recessions, he should pay more attention to his market timing. The model predicts equilibrium outcomes in a world where a fraction of managers have skill and invest alongside unskilled investors. The predictions about funds' covariance with payoff shocks, cross-fund dispersion, and their excess returns are all supported by the data. In turn, these findings offer new evidence to support two broader ideas: that some investment managers have skill and that attention is allocated rationally.
Kacperczyk, Marcin, Stijn Van Nieuwerburgh, and Laura Veldkamp. "A Rational Theory of Mutual Funds' Attention Allocation." Econometrica 84, no. 2 (March 2016): 571-626.
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