Hot Hands in Mutual Funds: The Persistence of Performance, 1974-87

The net returns of no-load mutual growth funds exhibit a hot-hands phenomenon during 1974-87. When performance is measured by Jensen's alpha, mutual funds that perform well in a one year evaluation period continue to generate superior performance in the following year. Underperformers also display short-run persistence. Hot hands persists in 1988 and 1989.
The success of the hot hands strategy does not derive from selecting superior funds over the sample period. The timing component -- knowing when to pick which fund -- is significant. These results are robust to alternative equity portfolio benchmarks, such as those that account for firm-size effects and mean reversion in returns. Capitilizing on the hot hands phenomenon, an investor could have generated a significant, risk-adjusted excess return of 10% per year.