Skill and Efficiency in the U.S. Mutual Fund Industry

May 2026

Skill and Efficiency in the U.S. Mutual Fund Industry

Dong Hwan Oh and Andrew J. Patton

Abstract:

We propose a new measure of mutual fund manager ability: "efficiency" is the ability to accrue the risk premium associated with a risk factor. The familiar abnormal return, or alpha, is shown to be the sum of two distinct measures of ability: "aggregate efficiency" which is the beta-weighted sum of the fund's (in)efficiencies across risk factors, and "skill," the component that is unrelated to factor exposures. Using a panel of U.S. equity mutual fund returns from 1999-2023, we document significant heterogeneity in mutual fund manager skill and efficiency. We employ regression trees and their extensions to capture this heterogeneity. We find that efficiency is more persistent than skill, and we show that future abnormal returns can be better predicted by decomposing lagged abnormal returns into skill and efficiency.

Keywords: mutual fund performance, trading costs, machine learning, heterogeneity

DOI: https://doi.org/10.17016/FEDS.2026.032

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