Impact of sector versus security choice on equity portfolios

We measure the contribution of industry sector choice and individual stock selection to the performance of 3350 United States' equity funds from 1980 to 2005. First, we demonstrate that sector choice makes a relatively greater contribution to portfolio variance, holding constant manager skill in identifying mispriced securities, and correcting for a bias in research methods previously applied to this issue. Second, using managers' reported stock holdings, we estimate the actual contribution of industry sector versus security choice to portfolio returns. Active managers of funds with a preference for small stocks with a style preference -- value or growth -- generate abnormal returns above those achieved by less active managers, consistent with managers having style-specific investment skills. This relative performance is attributed to the incremental returns generated from security selection over sector choice. Security selection also explains significantly more variation in returns across funds. These results imply that active managers make relatively greater use of security selection in forming portfolios which differ from benchmark.