On market timing and portfolio selectivity: modifying the Henriksson-Merton model

Abstract

This paper evaluates selected functionalities of the parametrical Henriksson-Merton test, a tool designed for measuring the market timing and portfolio selectivity capabilities. It also provides a solution to two significant disadvantages of the model: relatively indirect interpretation and vulnerability to parameter insignificance. The model has been put to test on a group of Polish mutual funds in a period of 63 months (January 2004 – March 2009), providing unsatisfactory parameter significance results. A modification to the structure of the equation was proposed in order to improve the versatility of the tool and make it easier to interpret. The modified model was later successfully verified on the same database. Consistent with prior literature, the empirical results indicated that the market timing and portfolio selectivity skills do have an impact on the level of excess portfolio returns.