Stocks Through a Looking Glass: Can Style Segment‐Adjusted Mutual Fund Active Holdings Predict Stock Returns?

ABSTRACT The stock selection (‘alpha’) decisions of fund managers who trade on firm‐specific information should have predictive return content. Faced with the same information, skilled fund managers make similar stock selection decisions. We introduce a new measure—stock investment quality—which uses fund quality to weight asymmetries in private information reflected in deviations of fund from peer group ownership on stocks in a style segment. We show stocks ranked high on investment quality generate significantly higher excess returns that persist through the ensuing year. The positive investment quality–future return relationship is robust to alternative fund quality proxies.