Performance persistence in U.S. mutual funds’ returns

Performance persistence signifies the ability of a mutual fund to gain returns on investment above a certain reference point on a continuous basis. This paper studies the impact of implementing the streak selection bias into the investigation about persistence in mutual fund performance. If the probability of flipping heads is 0.5, the streak selection bias implies that the probability conditional on an ongoing streak of flipping heads is lower than the underlying probability of 0.5. This streak selection bias was discovered by Miller and Sanjurjo (2018). Imagine a sample of similar mutual funds for which the probability of performing better than half of its peers is 0.5. If this fund experiences a streak of one period or more of performing better than half of its counterparts, the streak selection bias states that the conditional probability of performing better than half of the funds again in the next period is lower than the underlying probability of 0.5. A data set is constructed covering 27,718 U.S. equity funds over the 2010-2018 period which is used to assess the effect of accounting for the streak selection bias when performance persistence is measured. This is done by comparing two different research methods. One method does not take the streak selection bias into account and uses the uncorrected probability of 0.5 for a fund to perform better than half of the funds regardless of any ongoing streaks. The other method corrects for the streak selection bias by using the corrected conditional probability. This conditional probability differs in streak length. The results show that under the uncorrected probability persistence in mutual fund performance is only present in the short run. Mutual fund performance under the corrected probability persists both in the short and long run. This indicates that accounting for the streak selection bias increases the duration for which performance persistence in mutual funds occurs.