Investing Outside the Box: Fluctuating Styles of Actively Managed Funds

Managers of actively managed funds do not maintain a constant investment style. Instead, their factor loadings change over time. These changes are especially large following quarters with extreme returns and fund flows and arise from both active portfolio reallocations and passive style drift. Prior literature suggests that managers may alter styles for rational, behavioral, or incentive reasons, implying that the relationship between style changes and future returns may differ across funds. We introduce a new measure of manager skill, ``tactical investment skill,'' which captures a manager’s track record of increasing future returns through loadings changes. Results show that high-skill managers significantly outperform their low-skill peers in the subsequent month with the outperformance being