Fund Advisor Compensation in Closed-End Funds

This paper examines the relation between the premium on closed-end funds and organizational features of the funds and advisors, including the compensation scheme of the investment advisor. We find that the fund premium is larger when: (a) the advisor's compensation is more sensitive to fund performance; (b) the assets managed by the advisor are concentrated in the fund in question; (c) the advisor manages other funds with low compensation sensitivity to performance and with low concentration of assets managed by the advisor; and (d) the advisor's compensation contract evaluates performance relative to a benchmark.     

Pay-performance sensitivity and firm size: Insights from the mutual fund industry

I examine the ex ante decision to make an agent's pay-performance sensitivity an inverse function of organization size. I focus on mutual funds and their decision to use compensation contracts that reduce the advisor's marginal compensation as the fund grows (a declining-rate contract) over the dominant contract type, where marginal compensation is unrelated to fund size (a single-rate contract). I find evidence consistent with the view that declining-rate contracts are a mechanism to keep marginal compensation in line with the advisor's declining marginal product. Specifically, I find that funds with greater exposure to diseconomies of scale are more likely to use a declining-rate contract and to specify a greater amount of compensation decline in their contracts. Consistent with optimal contracting, I find no evidence of a performance difference between funds with declining-rate contracts and funds with single-rate contracts.     

Mutual fund performance: Using bespoke benchmarks to disentangle mandates,constraints and skill

While no two mutual funds are alike in terms of their mandates and constraints, metrics used to evaluate fund performance relative to peers typically fail to account for these differences by relying on generic benchmark indices and rankings. We develop a methodology to construct a conditional multi-factor benchmark that explicitly incorporates the details of a given fund’s mandates and constraints. The results suggest that (i) mandates and constraints are economically important and affect funds differently, (ii) in general, the average mutual fund has a much improved track record when comparing themselves to a bespoke benchmark, and (iii) the rank ordering of fund bespoke performance relative peers is significantly different than the original rank ordering suggesting advisors and board of directors would make better decisions regarding compensation and performance assessment respectively, if they incorporate the impact of mandates and constraints.     

Careers and Survival: Competition and Risk in the Hedge Fund and CTA Industry

Investors in hedge funds and commodity trading advisors (CTAs) are concerned with risk as well as return. We investigate the volatility of hedge funds and CTAs in light of managerial career concerns. We find an association between past performance and risk levels consistent with previous findings for mutual fund managers. Variance shifts depend upon relative rather than absolute fund performance. The importance of relative rankings points to the importance of reputation costs in the investment industry. Our analysis of factors contributing to fund disappearance shows that survival depends on absolute and relative performance, excess volatility, and on fund age.     

A unique view of hedge fund derivatives usage: Safeguard or speculation?

We study the common equity and equity option positions of hedge fund investment advisors over the 1999–2006 period. We find that hedge funds' stock positions predict future returns and that option positions predict both volatility and returns on the underlying stock. A quarterly tracking portfolio of stocks based on publicly observable hedge fund option holdings earns abnormal returns of 1.55% through the end of the quarter. Net of fees, hedge funds using options deliver higher benchmark-adjusted portfolio returns and lower risk than nonusers. The results suggest that hedge fund positions reflect significant timing and selectivity skill.     

Financial Gatekeepers and Investor Protection: Evidence from Criminal Background Checks

We examine whether financial advisors with pre‐advisor criminal records pose a greater risk to investors than those without. We find that financial advisors with pre‐advisor criminal records are more likely to receive future customer complaints. Their complaints are more likely to receive arbitration awards or settlements and are more likely to involve large settlements exceeding $100,000. Finally, clients are more likely to suffer service disruptions from engaging advisors with pre‐advisor criminal records, even incremental to the brokerage firm being high‐risk. Although we do not have performance data of individual advisors, mutual funds of those firms that employ advisors with criminal records do not provide their clients with superior returns nor charge lower fees, suggesting that there are not compensating benefits to offset the investor harm. Overall, pre‐advisor criminal record serves as an important ex ante characteristic available to regulators, investors, and employers for risk‐assessment purposes.     

MUTUAL FUND MORTALITY, 12B‐1 FEES,AND THE NET EXPENSE RATIO

The Securities and Exchange Commission is currently reviewing Rule 12b‐1, which governs how fund advisors may pay for the distribution of fund shares. We provide evidence that even after adjusting for economies of scale, funds with 12b‐1 fees have higher expense ratios net of the 12b‐1 fees than do funds without such fees. This finding suggests that 12b‐1 fees are more than just a deadweight cost. We also demonstrate that 12b‐1 fees are highest for funds that ultimately fail, that the proportion of funds with 12b‐1 fees is increasing over time, and that the level of those fees is also increasing over time.     

Commonalities in investment strategy and the determinants of performance in mutual fund mergers

This paper examines the determinants of cross-sectional variation in post-merger mutual fund performance. Mergers between funds with similar management objectives, as reflected by average portfolio book-to-market ratio, price–earnings ratio, beta and market capitalization values, outperform mergers between funds with dissimilar strategies. This superior performance transcends lower portfolio rebalancing costs which might be realized between merging funds which hold more assets in common. These results suggest that mutual fund mergers create collaborative benefits between funds with similar strategies. We also examine if fund governance structures influence the fund pairing process, testing if stronger fund oversight mitigates pairing mismatches. We find that less independent boards of trustees and boards with higher compensation are related to greater strategic mismatches between funds. These results suggest that more entrenched boards are more tolerant of fund mismatches which benefit the investment company, yet are not in investor’s best interests.     

Liquidity shocks,size and the relative performance of hedge fund strategies

We examine whether the increase in the flow of capital to hedge funds over the period 1994–2005 had a negative impact on performance. More specifically, we study the relative performance of small versus large funds for each of the hedge fund strategies. Our results indicate that on an absolute return basis, small funds outperform large funds. On a risk-adjusted return basis, however, we find that large funds outperform small funds, and that large funds are also shown to hold less liquid assets and take on less systematic and idiosyncratic risk than small funds. Further, funds that experience positive liquidity shocks generally outperform those that experience negative liquidity shocks. We also find evidence that hedge fund managers that are aggressive in dealing with liquidity shocks perform better than hedge fund managers that are conservative in dealing with liquidity shocks.     

Location Decisions of Domestic and Foreign-Affiliated Financial Advisors: Australian Evidence

We examine two views of the location choice of newly qualified personal financial advisors that recommend fund managers to retail investors. In one, sources of investment pools are the determinants of the location choice of financial advisors (the ‘source of funds’ hypothesis). In the other, investment advisors learn from and mimic the location of competing industries (the ‘knowledge spill-over’ hypothesis). We also investigate whether ownership structures, such as institutional and foreign affiliation, affect the location choices of advisors. Overall, advisor location is determined by considerations for the profitability of an area as a source of both investment funds and potential information spillovers from competitors. Institutional affiliation may result in differences in the set of relevant location choice factors, but does not detract from our main findings.     

Is Money Smart? A Study of Mutual Fund Investors' Fund Selection Ability

A previous study finds evidence to support selection ability among active fund investors for equity funds listed in 1982. Using a large sample of equity funds, I find evidence that funds that receive more money subsequently perform significantly better than those that lose money. This effect is short-lived and is largely but not completely explained by a strategy of betting on winners. In the aggregate, there is no significant evidence that funds that receive more money subsequently beat the market. However, it is possible to earn positive abnormal returns by using the cash flow information for small funds.     

Are mutual fund fees excessive?

There is a long running debate over whether competition in the mutual fund industry limits the ability of investment advisors to charge fees that are disproportionate to the services they provide. We posit that disproportionately high fees are prevalent in funds with multiple share classes and those with weak governance structures. Using a comprehensive sample of index mutual funds for the from 1998 to 2007, we find that internal governance mechanisms matter primarily for funds with relatively small share classes where investors often face increased search costs and/or restricted access to competitive mutual funds. Additionally, we find that funds managed by publicly held sponsors are associated with disproportionately higher fee spreads (about 28 basis points). The results are robust to the inclusion of board characteristics, share class structure, and investment objectives. Overall, our findings suggest that competition and agency considerations are important determinants in the pricing of mutual funds.     

Is ethical money financially smart? Nonfinancial attributes and money flows of socially responsible investment funds

We study the money flows into and out of socially responsible investment (SRI) funds around the world. In their investment decisions, investors in SRI funds may be more concerned with ethical or social issues than with fund performance. Therefore, SRI money flows are less related to past fund returns. Ethical money is less sensitive to past negative returns than are conventional fund flows, especially when SRI funds primarily use negative or Sin/Ethical screens. Social attributes of SRI funds weaken the relation between money inflows and past positive returns. However, money flows into funds with environmental screens are more sensitive to past positive returns than are conventional fund flows. Stock picking based on in-house SRI research increases the money flows. These results give evidence on the role of nonfinancial attributes, which induce heterogeneity of investor clienteles within SRI funds. We find no evidence of a smart money effect, as the funds that receive more inflows neither outperform nor underperform their benchmarks or conventional funds.     

Management sub-advising in the mutual fund industry

This is a study of how contractual mechanisms can mitigate agency conflicts in sub-advised mutual funds. Sub-advising contracts allow fund families to expand their product offerings to include new investment styles and thereby gain market share. We show that costly contractual arrangements, such as co-branding, multi-advising, and performance-based compensation, can mitigate agency conflicts in outsourcing and protect investors from potential underperformance. Fund families will find it cost-effective to implement such incentive mechanisms only when investors are sophisticated in assessing manager skill. The findings help to explain why a large percentage of fund families outsource their funds to advisory firms.     

Security Concentration and Active Fund Management: Do Focused Funds Offer Superior Performance?

We examine gross fund returns based on the number of securities held and find no evidence that focused funds outperform diversified funds. After deducting expenses, focused funds significantly underperform. Controlling for various fund characteristics, fund performance is positively related to the fund's number of holdings both before and after expenses. We find evidence linking focused fund underperformance to agency and liquidity problems. Finally, the attrition rate of focused funds is higher than that of diversified funds. These results do not support the view that managers holding focused portfolios have superior stock‐picking skills or that focused funds provide value to investors.     

Selling winners, holding losers: Effect on fund flows and survival of disposition-prone mutual funds

Recent studies suggest that presence of a disposition effect in a large subset of investors can create stock mispricings, which has serious implications for market efficiency. We examine whether US equity mutual funds are disposition-prone, how that effect influences performance, investor flows and fund survival, and whether the disposition orientation of mutual funds affects stock prices in a sustained manner.We find that about 30% of all funds exhibit some degree of disposition behavior and that such funds underperform funds that are not disposition-prone by 4-6% per year. Moreover, after controlling for performance, tax overhang and other factors that potentially affect flows, disposition-prone funds attract significantly smaller flows than other funds. The results suggest that mutual fund investors are smart enough to minimize investment in disposition-prone funds. Consequently, disposition-prone funds have significantly higher rates of failure than other funds, thereby reducing the impact of such trading behavior on security prices.     

Mutual Fund Tax Clienteles

Mutual funds are held by investors in taxable and tax‐qualified retirement accounts. We investigate whether the characteristics, investment strategies, and performance of mutual funds held by these diverse tax clienteles differ. Examining both mutual fund distributions and mutual fund holdings, we find that funds held primarily by taxable investors choose investment strategies that result in lower tax burdens than funds held primarily in tax‐qualified accounts. Despite these differences, we find no evidence that any investment constraints that may arise from these tax‐efficient investment strategies result in performance differences between funds held by different tax clienteles.     

Agency costs,governance, and organizational forms: Evidence from the mutual fund industry

Using a comprehensive sample of mutual funds and fund families for the period 1992–2004, this study examines the impact of fund management companies’ organizational forms on the level of agency costs within mutual funds. We find that, all else being equal: (1) funds managed by public fund families charge higher fees than those managed by private fund families; (2) public fund families acquire more funds than private fund families; and (3) funds of public fund families significantly underperform funds of private fund families. Collectively, these findings suggest that agency costs are higher in mutual funds managed by public fund families. Our results are consistent with the idea that the agency conflict between the fund management company and fund shareholders is more acute for public management companies because of their shorter-term focus.     

“和而不群”还是“卓尔不群”?——基于基金网络信息使用的视角

如何识别出优秀的基金管理者,理解其信息决策机制,对于优化资源配置、提升市场效率具有重要意义。本文探究了基金经理对自身所处基金网络中的共享信息的使用程度与其管理能力之间的关系。具体而言,本文通过基金的重仓持股构建了基金网络,采用基金自身交易与其所处网络中其他基金平均交易的偏离程度作为该基金对基金网络中信息使用的衡量。研究发现:(1)对基金网络中信息使用程度较低的基金的业绩要显著好于对基金网络中信息使用程度较高的基金。(2)更高的超额收益主要来源于基金经理优异的选股能力,虽由此承担了更多的异质性风险,却并未增大总体风险水平。(3)基金经理更换数据表明基金对网络内信息的使用程度更多地与基金经理特征相关而非与基金特征相关。(4)网络内信息使用程度直接反映了基金私有信息含量,因此更可能与基金经理能力相关。     

Is trading behavior stable across contexts? Evidence from style and multi-style investors

In this paper we study priming of identity within the context of inherent vs. contextual financial decision making. We use a sample of individual trading accounts in equity-style funds taken from one fund family to test the hypothesis that trading styles are inherent vs. contextual. Our sample contains investors who invest either in a growth fund, a value fund, or both. We document behavioral differences between growth fund investors and value fund investors. We find that their trades depend on past returns in different ways: growth fund investors tend towards momentum trading and value fund investors tend towards contrarian trading. These differences may be due to inherent clientele characteristics, including beliefs about market prices, specific personality traits and cognitive strategies that cause them to self-select into one or the other style. We use a sample of investors that trade in both types of funds to test this proposition. Consistent with the contextual hypothesis, we find that investors who hold both types of funds trade growth fund shares differently than value fund shares.