The Federal Reserve Board of Governors released a research paper titled “Skill and Efficiency in the U.S. Mutual Fund Industry,” authored by Dong Hwan Oh and Andrew J. Patton. The study introduces a new measure called “efficiency,” defined as a manager’s ability to capture the risk premium of a risk factor. It shows that the commonly used abnormal return, or alpha, can be split into two components: aggregate efficiency, the beta‑weighted sum of a fund’s efficiencies across risk factors, and skill, the portion unrelated to factor exposures. Using a panel of U.S. equity mutual‑fund returns from 1999 to 2023, the authors find significant heterogeneity in both skill and efficiency. They apply regression‑tree techniques and find that efficiency is more persistent than skill, and that future abnormal returns are better predicted when lagged returns are decomposed into these two components.
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