The holdings markup behavior of mutual funds: evidence from an emerging market

This paper uncovers a seasonal mutual fund holdings markup pattern in Taiwan’s market. Specifically, we find that fund’s equity holdings jump up significantly at the quarter-ends and year-end while drop back immediately to the previous level in the following month. While the holdings markup pattern found in this paper may look similar to the price markup phenomenon found by Carhart et al. (J Finance 57:661–693, 2002), the mechanism used by fund managers in the performance inflation may be quite different. In specific, while Carhart et al. (J Finance 57:661–693, 2002) document that fund managers use the stocks currently held in their portfolio to mark up the fund performance, we find that fund managers in fact use both the stocks already held in their portfolio and the new stocks to mark up their holdings. Furthermore, Carhart et al. (J Finance 57:661–693, 2002) do not explicitly examine if there exists a holdings markup in addition to the price markup. In this study, we fill this gap by directly exploring the holdings markup behavior by the fund managers. We also identify the specific stock characteristics that fund managers prefer in their holdings markup. In specific, fund managers prefer to trade growth stocks, stocks with larger market capitalization, higher institutional ownership, higher quality of earnings, and stocks in the high-tech industry, to inflate the fund performance. We also find that fund managers tend to avoid stocks that are herded by other funds.     

Mutual Fund Herding and the Impact on Stock Prices

We analyze the trading activity of the mutual fund industry from 1975 through 1994 to determine whether funds "herd" when they trade stocks and to investigate the impact of herding on stock prices. Although we find little herding by mutual funds in the average stock, we find much higher levels in trades of small stocks and in trading by growth-oriented funds. Stocks that herds buy outperform stocks that they sell by 4 percent during the following six months; this return difference is much more pronounced among small stocks. Our results are consistent with mutual fund herding speeding the price-adjustment process.     

The price of sin: The effects of social norms on markets

We provide evidence for the effects of social norms on markets by studying “sin” stocks—publicly traded companies involved in producing alcohol, tobacco, and gaming. We hypothesize that there is a societal norm against funding operations that promote vice and that some investors, particularly institutions subject to norms, pay a financial cost in abstaining from these stocks. Consistent with this hypothesis, we find that sin stocks are less held by norm-constrained institutions such as pension plans as compared to mutual or hedge funds that are natural arbitrageurs, and they receive less coverage from analysts than do stocks of otherwise comparable characteristics. Sin stocks also have higher expected returns than otherwise comparable stocks, consistent with them being neglected by norm-constrained investors and facing greater litigation risk heightened by social norms. Evidence from corporate financing decisions and the performance of sin stocks outside the US also suggest that norms affect stock prices and returns.     

The affect heuristic and stock ownership: A theoretical perspective

We consider asset prices and informational efficiency in a setting where owning stock confers direct utility due to an affect heuristic. Specifically, holding equity in brand name companies or those indulging in “socially desirable” activities (e.g., environmental consciousness) confers positive consumption benefits, whereas investing in “sin stocks” yields the reverse. In contrast to settings based on wealth considerations alone, expected stock prices deviate from expected fundamentals even when assets are in zero net supply. Stocks that yield high direct utility are, on average, more informationally efficient as they stimulate more entry into the market for these stocks and, consequently, more information collection. The analysis also accords with a value effect, high valuations of brand‐name stocks, abnormally positive returns on “sin stocks,” volume premia in the cross‐section of returns, proliferation of mutual funds and ETFs, and yields untested implications. If, as psychological literature suggests, agents derive greater utility from successful companies by “basking in reflected glory,” then asset prices react to public signals non‐linearly, leading to booms and busts, as well as crashes and recoveries.     

Flight-to-liquidity,market uncertainty,and the actions of mutual fund investors

We explore the trading decisions of equity mutual funds during ten periods of extreme market uncertainty. We find that mutual funds reduced their aggregate holdings of illiquid stocks. Exploring the drivers behind this result reveals that this is mainly driven by larger withdrawals from funds that hold less liquid stocks. We further find that the sell-off of illiquid stocks occurred only after initial deterioration in market conditions, consistent with retail investors’ response to bad performance. At a broader level, this shows that mutual funds consumed liquidity during periods where liquidity was most valuable. Moreover, the fact that fund managers traded in response to these withdrawals suggests a potentially magnifying channel for the drop in illiquid stock prices, also known as flight-to-liquidity.     

Measuring Mutual Fund Performance with Characteristic-Based Benchmarks

This article develops and applies new measures of portfolio performance which use benchmarks based on the characteristics of stocks held by the portfolios that are evaluated. Specifically, the benchmarks are constructed from the returns of 125 passive portfolios that are matched with stocks held in the evaluated portfolio on the basis of the market capitalization, book-to-market, and prior-year return characteristics of those stocks. Based on these benchmarks, “Characteristic Timing” and “Characteristic Selectivity” measures are developed that detect, respectively, whether portfolio managers successfully time their portfolio weightings on these characteristics and whether managers can select stocks that outperform the average stock having the same characteristics. We apply these measures to a new database of mutual fund holdings covering over 2500 equity funds from 1975 to 1994. Our results show that mutual funds, particularly aggressive-growth funds, exhibit some selectivity ability, but that funds exhibit no characteristic timing ability.     

Climate change news sensitivity and mutual fund performance

In the presence of rising concern about climate change that potentially affects risk and return of investors' portfolio companies, active investors might have dispersed climate change risk exposures. We compute mutual fund covariance with market-wide climate change news index and find that high (positive) climate news beta funds outperform low (negative) climate news beta funds by 0.24% per month on a risk-adjusted basis. High climate news beta funds tilt their holdings toward stocks with high potential to hedge against climate change news risk. In the cross section, such stocks yield higher excess returns, which are driven by greater pricing pressure and superior financial performance over our sample period.     

Investor Sentiment and the Closed-End Fund Puzzle

This paper examines the proposition that fluctuations in discounts of closed-end funds are driven by changes in individual investor sentiment. The theory implies that discounts on various funds move together, that new funds get started when seasoned funds sell at a premium or a small discount, and that discounts are correlated with prices of other securities affected by the same investor sentiment. The evidence supports these predictions. In particular, we find that both closed-end funds and small stocks tend to be held by individual investors, and that the discounts on closed-end funds narrow when small stocks do well.     

On the Stability of the Cross‐Section of Expected Stock Returns in the Cross‐Section: Understanding the Curious Role of Share Turnover

In this paper, we shed further light on cross‐sectional predictors of stock return performance. Specifically, we explore whether the cross‐section of expected stock returns is robust within stock groups sorted by past monthly return. We find that the book/market and momentum effects are remarkably robust to sorting on past returns. However, share turnover is negatively related to future returns for stocks with abnormally low stock price performance in the recent past, but postively related to returns for well‐performing stocks. This casts doubt on the use of turnover as a liquidity proxy, but is consistent with turnover being a proxy for momentum trading which pushes prices in the direction of past price movements. Our results are robust to both NYSE/AMEX and Nasdaq stocks, and also robust to stratifying the sample by time period.     

Small-cap equity mutual fund managers as liquidity providers

This paper examines the relation between the performance of small-cap equity mutual funds and the liquidity characteristics of their asset holdings. We study the trading behavior of fund managers and show that on average, they tend to buy less liquid stocks and sell more liquid stocks. We introduce the notion of net “liquidity creation” by fund managers and examine its role in explaining the cross section of small-cap equity mutual fund returns. Our empirical results show that on average, small-cap mutual fund managers are able to earn an additional 1.5% return per year as compensation for providing such liquidity services to the market.     

Analyst Disagreement,Mispricing, and Liquidity*

This paper documents a close link between mispricing and liquidity by investigating stocks with high analyst disagreement. Previous research finds that these stocks tend to be overpriced, but that prices correct downwards as uncertainty about earnings is resolved. Our analysis suggests that one reason mispricing has persisted through the years is that analyst disagreement coincides with high trading costs. We also show that in the cross‐section, the less liquid stocks tend to be more severely overpriced. Additionally, increases in aggregate market liquidity accelerate the convergence of prices to fundamentals. As a result, returns of the initially overpriced stocks are negatively correlated with the time series of innovations in aggregate market liquidity.     

Retail Financial Innovation and Stock Market Dynamics: The Case of Target Date Funds

Target date funds (TDFs) are designed to provide unsophisticated or inattentive investors with age-appropriate exposures to different asset classes like stocks and bonds. The rise of TDFs has moved a significant share of retirement investors into macrocontrarian strategies that sell stocks after relatively good stock market performance. This rebalancing drives contrarian flows across equity mutual funds held by TDFs, stabilizing their funding, and reduces stock returns for stocks disproportionately held by these funds when stock market returns are relatively high. Continued growth in TDFs and similar investment products may dampen stock market volatility and increase the transmission of shocks across asset classes.     

不同基金持股与股票波动性分解组分关系的实证研究

本文从2004年到2006年第一季度的重仓股中选取259只典型重仓股,利用从1999年到2006年第一季度的财务及交易数据,采用Panel Data方法中的FE模型对开放基金和封闭基金持股与股票的系统波动及个别波动之间的关系进行了分析,得出开放基金比封闭基金更利于稳定股票的系统波动,而对个别波动,开放和封闭基金都既不会降低,也没有扩大的结论,最后为基金业的发展提出了一些建议。     

STOCK PRICES AND INFLATION

Numerous empirical studies establish that inflation has a negative short‐run effect on stock returns but few studies report a positive, long‐run Fisher effect for stock returns. Using stock price and goods price data from six industrial countries, we show that long‐run Fisher elasticities of stock prices with respect to goods prices exceed unity and range from 1.04 to 1.65, which tends to support the Fisher effect. We also find that the time path of the response of stock prices to a shock in goods prices exhibits an initial negative response, which turns positive over longer horizons. These results help reconcile previous short‐run and long‐run empirical evidence on stock returns and inflation. Also, they reveal that stock prices have a long memory with respect to inflation shocks, such that investors should expect stocks to be a good inflation hedge over a long holding period. JEL Classification: G12     

Explaining persistence in mutual fund performance

This study investigates the determinants of persistence in mutual fund performance. Previous research that uses factor-mimicking portfolios and characteristic benchmarks to model fund performance fails to explain all the persistence in fund returns. This study employs a model that directly relates mutual fund returns to the characteristics of the stocks held by funds. Adjusting fund returns for the size of the stocks in which funds invest and financial ratios intended to capture fund manager investment styles explains all the persistence in mutual fund returns from 1976–1985, the period in which persistence is most prevalent.     

Short-horizon incentives and stock price inflation

Do managerial incentive horizons have capital market consequences? We find that they do when short-sale constraints are more binding. Firms experience significant stock price inflation when their CEOs have short horizon incentives. The short-horizon CEOs sell more shares at inflated prices and generate greater abnormal trading profits. The stock price inflation is partly explained by greater earnings surprises and more positive investor reaction to the surprises. To inflate stock prices, short-horizon firms are more likely to employ income-increasing discretionary accruals. Consistent with theoretical predictions, all these effects are attenuated or statistically insignificant when short-sale constraints are less binding.     

Do foreign purchases of U.S. stocks help the U.S. stock market?

This paper investigates the relationship between the U.S. S&P 500 stock market and purchases of U.S. corporation stocks by foreign investors. Estimations using monthly data from 1978:1 to 2008:7 under various methodologies show that, controlling for asset prices (interest rates and the yield curve) and inflation, purchases of U.S. stocks by foreign investors have a positive and statistically significant impact on the U.S. stock market performance. We also show that their relationship is time variant. In a global world, the demand-side variable captured by the foreign appetite for U.S. stocks attenuates the negative effects associated with the domestic forces.     

Can Mutual Fund “Stars” Really Pick Stocks? New Evidence from a Bootstrap Analysis

We apply a new bootstrap statistical technique to examine the performance of the U.S. open‐end, domestic equity mutual fund industry over the 1975 to 2002 period. A bootstrap approach is necessary because the cross section of mutual fund alphas has a complex nonnormal distribution due to heterogeneous risk‐taking by funds as well as nonnormalities in individual fund alpha distributions. Our bootstrap approach uncovers findings that differ from many past studies. Specifically, we find that a sizable minority of managers pick stocks well enough to more than cover their costs. Moreover, the superior alphas of these managers persist.     

Do Funds Make More When They Trade More?

We model fund turnover in the presence of time‐varying profit opportunities. Our model predicts a positive relation between an active fund's turnover and its subsequent benchmark‐adjusted return. We find such a relation for equity mutual funds. This time‐series relation between turnover and performance is stronger than the cross‐sectional relation, as the model predicts. Also as predicted, the turnover‐performance relation is stronger for funds trading less‐liquid stocks and funds likely to possess greater skill. Turnover is correlated across funds. The common component of turnover is positively correlated with proxies for stock mispricing. Turnover of similar funds helps predict a fund's performance.     

Order Flows and Stock Returns: Compensation for Market Makers with Inventory Concerns

We investigate whether market makers with inventory concerns are compensated with subsequent monthly returns in the cross‐section. We find a significant negative relation between order flows and monthly returns, “the order flow effect,” suggesting that market makers lower prices for stocks with sell order flows and demand a reward in the form of higher expected returns. Further, the order flow effect is stronger for high‐volatility or high‐volume stocks for which market makers have serious inventory concerns. Funding liquidity of market makers also affects the order flow effect. Finally, our finding is independent of existing regularities and robust to the decimalization.