Decomposing Fund Activeness

Decomposing mutual funds’ tracking error into its idiosyncratic and systematic components is informative about funds’ intention to implement picking and timing strategies.
Accordingly, we define the fraction of a fund’s active return variance that is idiosyncratic as
the fund’s degree of picking (dop), and document that pickers (high-dop funds) exhibit higher
performance than timers (low-dop funds). We rule out that this outperformance is driven
by different decreasing returns to scale across strategies, different levels of fund activeness,
idiosyncratic risk, and fund styles. We also provide new evidence on the dynamics of fund
strategies over business cycles and the fund life-cycle