Are mutual funds sitting ducks?

We find that patient traders profit from the predictable, flow-induced trades of mutual funds. In anticipation of a 1%-of-volume change in mutual fund flows into a stock next quarter, the institutions in the same 13F category as hedge funds trade 0.29–0.45% of volume in the current quarter. A third of the trading is associated with the subset of 504 identified hedge funds. The effect is stronger when quarterly mutual fund portfolio disclosure is required and among hedge funds with more patient capital. A one standard deviation higher measure of anticipatory trading by a hedge fund is associated with a 0.9% higher annualized four-factor alpha. A one standard deviation higher measure of anticipation of a mutual fund's trades by institutions is associated with a 0.07–0.15% lower annualized four-factor alpha. The effect is stronger for more constrained mutual funds.     

New Zealand mutual funds: measuring performance and persistence in performance

The present study investigates the performance of New Zealand mutual funds using a survivorship‐bias controlled sample of 143 funds for the period of 1990–2003. Our overall results suggest that New Zealand mutual funds have not been able to provide out‐performance. Alphas for equity funds, both domestic and international, are insignificantly different from zero, whereas balanced funds underperform significantly. There is no evidence of timing abilities by the fund managers. In the short term, significant evidence of return persistence for all funds is observed. This persistence, however, is driven by ‘icy hands’ rather than ‘hot hands’. Finally, we find the risk‐adjusted performance for equity funds to be positively related to fund size and expense ratio and negatively related to load charges.     

The impact of prior performance on the risk-taking of mutual fund managers

We analyze the impact of prior performance on the risk-taking behavior of mutual fund managers. We contribute to the existing literature by using different measures of risks, a larger data set, and an econometric approach capturing non-linear effects and assigning exact probabilities to the mutual fund managers’ adjustment of behavior. We find that prior performance in the first half of the year has, in general, a positive impact on the choice of the risk level in the second half of the year. Successful fund managers increase the volatility, the beta, and assign a higher proportion of their portfolio to value stocks, small firms, and momentum stocks in comparison to unsuccessful fund managers. Unsuccessful fund manager increase, on average, only the tracking error. We thank an anonymous referee, Bernd Brommundt, Alexander Ising, Stephan Kessler, Axel Kind, Angelika Noll, Jennifer Noll, Ralf Seiz, Stephan Süss, Rico von Wyss, and Andreas Zingg for valuable comments. We acknowledge helpful comments of the participants from the Joint Research Workshop of the University of St. Gallen and the University of Ulm in 2005.     

Stock weighting and nontrading bias in estimated portfolio returns

Liu and Strong (2008) note that researchers often employ a simple (but incorrect) averaging approach that induces significant error into estimated buy‐and‐hold portfolio returns. This study explores the additional challenges that arise when stocks are subject to nontrading. We develop a decomposition of the total bias in estimated return into the components attributable to the stock weighting approach and the treatment of nontrading. While the latter is shown to be negligible, the former can approach 150 basis points per month. Our empirical analysis of Australian equities shows that the simple averaging approach tends to overstate the size and book‐to‐market effects, and understate the momentum effect.     

Investor risk evaluation in the determination of management incentives in the mutual fund industry

This paper examines the way in which investors evaluate risk in deciding which mutual funds to invest. New fund investment is found to be positively related to a distributed lag of past fund performance with a strong degree of inertia. The relationship is mostly linear with significant nonlinearities at the upper (and possibly the lower) end of the performance spectrum. Investors appear to use publicly available data in a way that is consistent with the theory, giving equal weight in their decisions to the return and market risk components of the performance measure, while ignoring diversifiable risk. Finally, it is shown that improved performance in any year has a significant impact on the earnings of the management company. Because managers are rewarded on the basis of risk adjusted returns, risk neutral managers have no incentive to manipulate risk, except at very high performance levels.     

Government policy and ownership of equity securities

Since World War II, direct stock ownership by households across the globe has largely been replaced by indirect stock ownership by financial institutions. We argue that tax and retirement policies are among the factors behind these changes. We develop empirical measures of two tax incentives of holding stocks inside tax-deferred plans, tax-free investment income and the smoothing benefit. Using long time-series from eight countries, we show that the fraction of household ownership decreases with these measures of the tax benefits. This finding contributes to policy debates on effective taxation and to financial economics research on the long-term effects of taxation on corporate finance and asset prices.     

Momentum investing and the asset allocation decision

This study examines the active asset allocation decisions of Australian multisector fund managers to determine whether active fund managers engage in momentum strategies. We find evidence supporting the existence of momentum investing in active asset allocation strategies. This evidence exists in the Australian Equities, Australian Fixed Interest and Listed Property asset classes. Interestingly, balanced funds adopt contrarian strategies in the International Equities asset class. We also examine whether there is any association between a fund's market timing skill and the execution of momentum strategies. Our results show that fund managers with no market timing skill are momentum investors.     

Herding by mutual funds: impact on performance and investors’ response†

In this paper we investigate whether herding by actively managed equity funds affects their performances and flows over the 1980–2013 period. We show that during the herding quarter, on average, funds that trade with the herd benefit from this behavior. Although this does not directly translate into a positive association between the extent to which funds herd and their subsequent performance, we find that the funds that follow the herd earn negative abnormal returns whereas the ones that lead earn no abnormal returns. Our results also indicate that investors react adversely to follower funds while they are neutral towards the leader funds.     

Information flows within financial conglomerates: Evidence from the banks–mutual funds relation

We study how information flows within financial conglomerates by analyzing the relations between mutual funds and banks that belong to the same financial group. We investigate the effect that the lending behavior of affiliated banks has on the portfolio choice of the mutual funds that are part of the same group. We show that funds (fund families) increase their stakes in the firms that borrow from their affiliated banks in the period following the deal by far greater amounts than other unaffiliated funds (fund families). We provide evidence that this strategy is information-driven. The performance of the positions of affiliated funds in the stocks of borrowing firms exceeds that of their other positions in nonborrowing stocks located in the same industry as well as that of other stocks having similar characteristics by up to 1.6% per month. Funds increase (decrease) their stock holdings in those borrowing stocks that subsequently provide positive (negative) abnormal returns, suggesting that they exploit privileged inside information not available to other market participants. This behavior is prevalent largely in funds located in close geographic proximity to their lending banks. Furthermore, it is exhibited mostly by young, small, and poorly performing fund families. Our evidence points to information flows within conglomerates through informal channels such as personal acquaintances.     

Conditional risk and performance evaluation: Volatility timing, overconditioning, and new estimates of momentum alphas

Unconditional alphas are biased when conditional beta covaries with the market risk premium (market timing) or volatility (volatility timing). We demonstrate an additional bias (overconditioning) that can occur any time an empiricist estimates risk using information, such as a realized beta, that is not available to investors ex ante. Calibrating to U.S. equity returns, volatility timing and overconditioning can plausibly impact alphas more than market timing, which has been the focus of prior literature. To correct market- and volatility-timing biases without overconditioning, we show that incorporating realized betas into instrumental variables estimators is effective. Empirically, instrumentation reduces momentum alphas by 20-40%. Overconditioned alphas overstate performance by up to 2.5 times. We explain the sources of both the volatility-timing and overconditioning biases in momentum portfolios.     

Information asymmetry,mutual funds and earnings management: Evidence from China

This paper investigates how information asymmetry and mutual fund ownership affect listed companies’ earnings management. We show that (1) reducing information asymmetry improves firms’ earnings management behavior; (2) relative to short-term mutual funds, long-term mutual funds promote earnings quality by adopting a monitoring role; and (3) by dividing firms into high/low information asymmetry groups, we find that the information environment significantly increases the effect of long-term mutual funds on firms’ earnings management. In this paper, we provide new evidence for the role that institutional investors play in a typical emerging capital market. Our results have clear policy implications: to increase earnings quality, it is essential to improve information transparency and develop long-term institutional investors.     

Timing and selectivity in Portuguese mutual fund performance

We extend the international evidence on timing and selectivity skills of fund managers by applying the Henriksson and Merton [Henriksson, R., Merton, R., 1981. On market timing and investment performance. II. Statistical procedures for evaluating forecasting skills. J. Bus. 54, 513–533] model to Portuguese based mutual funds investing in local, European and International equity.

The results show that managers do not exhibit selectivity and timing abilities, and there is even some evidence of negative timing. Furthermore, we observe a distance effect on stock selection performance, since fund managers that invest locally seem to perform better that those who invest in foreign markets. However, this effect is reverted with respect to market timing skills of fund managers, suggesting that International fund managers are more focused in market timing strategies.