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.     

Mutual fund flows,expected returns,and the real economy

This paper investigates the relation between mutual fund flows and the real economy. The findings of this paper support the theory that the positive co-movement of flows into equity funds and stock market returns is explained by a common response to macroeconomic news. Variables that predict the real economy as well as the equity premium – in particular dividend-price ratio, default spread, relative T-Bill rate and consumption-wealth ratio – are related to fund flows and can account for the correlation of flows and market returns. Furthermore, consistent with the information-response hypothesis, mutual fund flows are forward-looking and predict real economic activity.     

Higher risk,lower returns: What hedge fund investors really earn

The returns of hedge fund investors depend not only on the returns of the funds they hold but also on the timing and magnitude of their capital flows in and out of these funds. We use dollar-weighted returns (a form of Internal Rate of Return (IRR)) to assess the properties of actual investor returns on hedge funds and compare them to buy-and-hold fund returns. Our main finding is that annualized dollar-weighted returns are on the magnitude of 3% to 7% lower than corresponding buy-and-hold fund returns. Using factor models of risk and the estimated dollar-weighted performance gap, we find that the real alpha of hedge fund investors is close to zero. In absolute terms, dollar-weighted returns are reliably lower than the return on the Standard & Poor's (S&P) 500 index, and are only marginally higher than the risk-free rate as of the end of 2008. The combined impression from these results is that the return experience of hedge fund investors is much worse than previously thought.     

Daily mutual fund flows and redemption policies

We examine how redemption policies affect daily fund flows in open-end mutual funds. Since short-term trading of fund shares, as manifested in daily fund flows, can have an adverse impact on returns to the fund’s shareholders, mutual funds might find it desirable to discourage short-term trading through the use of redemption fees. However, if daily fund flows are due to fund shareholders’ legitimate liquidity demands, the redemption fee would have little effect on daily fund flows and possibly adversely affect fund shareholders by imposing a liquidity cost on them. We find that the likelihood of a fund charging a redemption fee is largely a function of its overall fee structure. We also use a sample of funds that imposed redemption fees to examine whether the distribution of daily fund flows changes after the initiation of the redemption fee. We find that the redemption fee is an effective tool in controlling the volatility of fund flows.     

The dynamics between stock returns and mutual fund flows: empirical evidence from the Greek market

This paper examines the interaction between mutual fund flows and stock returns in Greece. Specifically, we investigate the possibility of a causality mechanism through which mutual funds flows may affect stock returns and vice versa. The statistical evidence derived from the error correction model indicates that there is a bidirectional causality between mutual fund flows and stock returns. Cointegration results show that mutual funds flows cause stock returns to rise or fall. This may be explained by the fact that, in Greece, equity mutual funds are obliged by law to invest a certain percentage of their cash in stocks. Thus, inflows and outflows of cash in equity funds seem to cause higher and lower stock returns in Greek stock market.     

Socially responsible investment funds: Investor reaction to current and past returns

This paper investigates and compares the determinants of fund flows for socially responsible investment (SRI) funds and conventional funds. We consider the impact of current and past measures of monthly and annual return on fund flow. The results suggest SRI fund flows are less sensitive to returns than conventional funds. Our model also shows that flow is persistent and SRI investors are more likely to invest in a fund they already own relative to conventional investors. These results reflect the difficulty SRI investors face in finding alternative investments that meet their non-financial goals.     

Performance aspects of Greek bond mutual funds

This paper examines the performance characteristics of Greek bond funds and the impact of fund flows on portfolio returns. The evidence shows that on average bond funds do not offer risk-adjusted profits exceeding the returns of the benchmark index, which is in consistence with the US and international evidence. Returns before fees are slightly superior to the returns of the benchmark index, but when fees are considered they lag considerably. The security selection and market timing skills of fund managers are also tested using both an unconditional and a conditional model to test for the impact of public information variables. We also find that fund flows impact negatively on market timing.     

Derivative use,fund flows and investment manager performance

Prior literature which examines the use of derivatives by investment managers does not discern between different types of derivative trading strategies. This study is the first to examine and gather data on a particular type of derivative trading strategy undertaken by investment managers. We examine the extent to which equity fund managers use index futures to manage fund flows and the effect this has on their alpha and market timing measures of performance. Our results show that funds that do not use derivatives exhibit lower returns and negative market timing skills when they experience fund flow. The performance of funds that use derivatives, however, is independent of investor’s liquidity demands. In fact, the unconditional performance of the average user fund is statistically equivalent to the performance of the average non-user fund conditional on zero fund flow. Our results provide evidence that derivatives can be beneficial for mutual fund holders under certain conditions.     

Dumb money: Mutual fund flows and the cross-section of stock returns

We use mutual fund flows as a measure of individual investor sentiment for different stocks, and find that high sentiment predicts low future returns. Fund flows are dumb money–by reallocating across different mutual funds, retail investors reduce their wealth in the long run. This dumb money effect is related to the value effect: high sentiment stocks tend to be growth stocks. High sentiment also is associated with high corporate issuance, interpretable as companies increasing the supply of shares in response to investor demand.     

Winners in the spotlight: Media coverage of fund holdings as a driver of flows

We show that media coverage of mutual fund holdings affects how investors allocate money across funds. Fund holdings with high past returns attract extra flows, but only if these stocks were recently featured in the media. In contrast, holdings that were not covered in major newspapers do not affect flows. We present evidence that media coverage tends to contribute to investors? chasing of past returns rather than facilitate the processing of useful information in fund portfolios. Our evidence suggests that media coverage can exacerbate investor biases and that it is the primary mechanism that makes fund window dressing effective.     

Mutual fund volatility timing and management fees

This paper shows that compensation incentives partly drive fund managers’ market volatility timing strategies. Larger incentive management fees lead to less counter-cyclical or more pro-cyclical volatility timing. But fund styles or aggregate fund flows could also account for this relation; therefore, we control for them and find that the relation between fees and volatility timing still holds. Results show that less aggressive fund styles are associated with pro-cyclical volatility timing, and that volatility timing and flow timing are negatively related. We also find that pro-cyclical timing mostly improves funds’ average excess returns, Sharpe ratios, and alphas.     

Closing and cloning in open-end mutual funds

Using a unique dataset, we document that only those closed funds for which no new fund is subsequently launched continuously deliver positive abnormal returns. This suggests the existence of an optimal fund scale. In spite of the potential diseconomies of scale, a non-trivial proportion of closed funds have new funds cloned—the scale motive would not be a complete explanation for the closure. When managers of closed funds clone new funds, they receive greater public attention and thus can attract more fund flows and charge higher fees. Furthermore, better-performing closed fund managers attract more fund flows to their new siblings, making the closure an effective mechanism to extract economic rents. Overall, we find that closing and cloning is an attractive strategy for funds seeking to increase their management fees and funds with more managers in place. Aspects of the closed fund family also affect the launch decision of new siblings.     

Performance Manipulation and Fund Flow: Evidence from China

In this paper, we assess the relation between fund flow and fund returns in China's open-ended fund industry. Analyzing quarterly data from the period January 2005-December 2012, we construct a simultaneous equation model that captures the endogeneity of current and past returns and flows and find that contemporaneous returns have a key role in determining fund flows. We then estimate the fund performance "manipulation degree" to further investigate the performance manipulation effect on fund flows. We find that manipulated funds can attract an additional flow of money and that, notably, individual rather than institutional investors are more likely to be deceived by manipulative behavior.     

Dedicated REIT Mutual Fund Flows and REIT Performance

This study examines the effects of weekly and monthly capital flows into the dedicated REIT mutual fund sector on aggregate REIT returns and, simultaneously, the effects of industry-level REIT returns on subsequent REIT mutual fund flows. The dynamic relation between REIT capital flows and returns is estimated using vector autoregression (VAR) techniques. Unlike static regression techniques, our dynamic model produces estimates of the short-run relationships, long-run relationships, impulse response functions, and forecast variance decompositions. We find evidence that REIT mutual fund flows are positively and significantly related to prior returns, while prior REIT mutual fund flows do not significantly influence REIT returns. However, contemporaneous flows do appear to have an initial positive effect, which is partially reversed one period later. The positive contemporaneous effect, however, is the result of unexpected REIT mutual fund flows, while the expected portion is insignificant.     

Optimal Number of Stock Holdings in Mutual Fund Portfolios Based on Market Performance

Among the decisions that most mutual fund portfolio managers make is the number of stocks to hold. We posit that there is an optimal number of stocks for each mutual fund, reflecting the trade‐off between diversification benefits versus transactions and monitoring costs. We find a significant quadratic relation between number of stock holdings and risk‐adjusted returns for U.S. equity mutual fund portfolios during 1992–2000. Moreover, we find that changes in the number of stocks held over time are more highly correlated with mutual fund flows than with funds' investment returns.     

International fund investment and local market returns

International fund investment in bonds and equities is characterized by a positive association between current net inflows and contemporaneous and past market returns: positive-feedback trading, while being possibly profitable for international fund investors, could be destabilizing for the underlying markets. Allowing for interactions between equity investment and bond investment, our panel vector autoregression shows that past equity returns contain useful information in forecasting equity and bond flows and that bond flows impact future equity returns positively.     

Allocation of decision rights and the investment strategy of mutual funds

The literature suggests that while decentralized decision making can allow for greater specialization in an organization, it heightens the cost of coordinating decisions. The mutual fund industry—in particular, sole- and team-managed balanced funds—provides an ideal setting to test the specialization versus coordination trade-off, as information on decision structures and fund actions is easily obtained. We show that sole-managed balanced funds, with centralized decision rights, exhibit significant market timing that requires reallocation across asset classes. However, consistent with coordination difficulties between managers specializing in particular asset classes, no market timing is evident in team-managed balanced funds. Team-managed funds exhibit greater returns from specialization, in the form of better security selection performance than sole-managed funds. These results hold cross-sectionally and for funds that switch management structures. The overall returns across different management structures are similar, indicating a market equilibrium. Investor flows reward market-timing performance for sole- but not team-managed funds.     

The liquidity risk of liquid hedge funds

This paper evaluates hedge funds that grant favorable redemption terms to investors. Within this group of purportedly liquid funds, high net inflow funds subsequently outperform low net inflow funds by 4.79% per year after adjusting for risk. The return impact of fund flows is stronger when funds embrace liquidity risk, when market liquidity is low, and when funding liquidity, as measured by the Treasury-Eurodollar spread, aggregate hedge fund flows, and prime broker stock returns, is tight. In keeping with an agency explanation, funds with strong incentives to raise capital, low manager option deltas, and no manager capital co-invested are more likely to take on excessive liquidity risk. These results resonate with the theory of funding liquidity by Brunnermeier and Pedersen (2009).     

Conditional Properties of Hedge Funds: Evidence from Daily Returns*

Using daily returns on a set of hedge fund indices, we study (i) the properties of the indices' conditional density functions and (ii) the presence of asymmetries in conditional correlations between hedge fund indices and other investments and between hedge fund indices themselves. We use the SNP approach to obtain estimates of conditional densities of hedge fund returns and then proceed to examine their properties. In general, a nonparametric GARCH(1,1) model appears to provide the best fit for all strategies. We find that the conditional third and fourth moments are significantly affected by changes in the current volatility of returns on hedge fund indices. We examine changes in the conditional probability of tail events and report significant changes in the probability of extreme events when the conditioning information changes. These results have important implications for models of hedge fund risk that rely on probability of tail events. We formally test for the presence of asymmetries in conditional correlations to determine if there is contagion between hedge funds and other investments and between various hedge fund indices in extreme down markets versus extreme up markets. We generally do not find strong evidence in support of asymmetric correlations.     

Tax Calendar Effects in the Municipal Bond Market: Tax‐Loss Selling and Cherry Picking by Investors and Market Timing by Fund Managers

Examining municipal bond returns, bond fund flows and buying activities by fund managers over the period 1990–2009, we find evidence of tax calendar‐related rational opportunistic trading patterns by fund investors and fund managers. Specifically, fund shareholders conduct tax‐loss selling in December and re‐invest in January. In April, June, and September, fund investors rationally cherry pick to sell their shares of short‐term bond funds instead of their shares of long‐term bond funds to raise cash to pay estimated taxes. Unlike fund shareholders, fund managers adopt a contrarian strategy of buying in December and selling in January.