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In principle, asset managers should trade more when they discover alpha generating trading opportunities. Thus, the performance of skilled managers should be better after an increase in trades, which implies a positive relationship between an investment fund’s turnover and subsequent returns. Pastor, Stambaugh and Taylor (2017) analyse the turnover of investment funds facing time-varying investment opportunities. They develop a model where before fee future abnormal performance, measured by alpha, is a function of current turnover.
In their model, future above fee abnormal performance is concave whereas the trading cost function is convex in turnover. The fund manager is supposed to maximise expected future profit net of trading costs. This leads to an optimal turnover...
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