The literature assessing whether mutual fund managers have skill
typically regards skill as an immutable attribute of the manager or the
fund. Yet, many measures of skill, such as returns, alphas, and measures
of stock-picking and market-timing, appear to vary over the business
cycle. Because time-varying ability seems far-fetched, these results
call into question the existence of skill itself. This paper offers a
rational explanation, arguing that skill is a general cognitive ability
that can be applied to different tasks, such as picking stocks or market
timing. Using tools from the rational inattention literature, we show
that the relative value of these tasks varies cyclically. The model
generates indirect predictions for the dispersion and returns of fund
portfolios that distinguish this explanation from others and which are
supported by the data. In turn, these findings offer useful evidence to
support the notion of rational attention allocation
