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Abstract:
Financial theory is often based on the belief that the actions of rational investors determine prices, which leads to the elimination of dominated financial instruments. Recently a series of articles have been published which question the rationality of investor behavior. Standard and Poor s 500 index funds represent one of the simplest vehicles for examining whether investors make rational decisions consistent with the normal paradigm of financial economics. S&P 500 index funds hold virtually the same securities, yet they differ by more than two percent per year in the fees they charge investors and the returns they offer investors. In this paper, we show that the relative returns offered by alternative S&P index funds are easily predictable. We show that the other important aspects of performance, risk and tax efficiency, are also easily predictable. Despite this predictability, the relationship between new cash flows and performance is much weaker than we would expect based on rational behavior. Marketing and spillover account for some, but only a small amount, of the cash flows not accounted for by performance. We show that selecting funds based on low expenses or high past returns leads to a portfolio that outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

Abstract:
Financial theory is often based on the belief that the actions of rational investorsdetermine prices, which leads to the elimination of dominated financial instruments. Recently a series of articles have been published which question therationality of investor behavior. Standard and Poor s 500 index funds represent one of the simplest vehicles for examining whether investors make rational decisions consistent with the normal paradigm of financial economics. S&P 500 index funds hold virtually the same securities, yet they differ by more than two percent per year in the fees they charge investors and the returns they offerinvestors. In this paper, we show that the relative returns offered by alternativeS&P index funds are easily predictable. We show that the other important aspects of performance, risk and tax efficiency, are also easily predictable. Despite this predictability, the relationship between new cash flows and performance is much weaker than we would expect based on rational behavior. Marketing and spillover account for some, but only a small amount, of the cash flows not accounted for by performance. We show that selecting funds based on low expenses or high past returns leads to a portfolio that outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

Abstract:
Financial theory is often based on the belief that the actions of rational investors determine prices, which leads to the elimination of dominated financial instruments. Recently a series of articles have been published which question the rationality of investor behavior. Standard and Poor's 500 index funds represent one of the simplest vehicles for examining whether investors make rational decisions consistent with the normal paradigm of financial economics. S&P 500 index funds hold virtually the same securities, yet they differ by more than two percent per year in the fees they charge investors and the returns they offer investors. In this paper, we show that the relative returns offered by alternative S&P index funds are easily predictable. We show that the other important aspects of performance, risk and tax efficiency, are also easily predictable. Despite this predictability, the relationship between new cash flows and performance is much weaker than we would expect based on rational behavior. Marketing and spillover account for some, but only a small amount, of the cash flows not accounted for by performance. We show that selecting funds based on low expenses or high past returns leads to a portfolio that outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

rationality, index funds, mutual funds

Abstract:
Existing studies of mutual fund market timing analyze monthly returns and find little evidence of timing ability. We show that daily tests are more powerful and that mutual funds exhibit significant timing ability more often in daily tests than in monthly tests. We construct a set of synthetic fund returns in order to control for spurious results. The daily timing coefficients of the majority of funds are significantly different from their synthetic counterparts. These results suggest that mutual funds may possess more timing ability than previously documented.

Abstract:
The Morning Call and Midday Call segments on CNBC TV provide a unique opportunity to shed light on the efficient market hypothesis. The segments report analysts' views about individual stocks and are broadcast when the market is open. We find that prices respond to the reports within seconds of the initial mention, with positive reports fully incorporated within one minute. The impact of negative reports is gradual, lasting 15 minutes. We find compelling evidence that viewers trade based on the information in the segments. Trading intensity doubles in the minute after the stock is mentioned on air, with a significant increase in buyer- (seller-) initiated trades after positive (negative) reports. Traders who lock in prices within 15 seconds of the initial mention make small but significant profits by trading on positive reports during the Midday Call. Our results highlight the role that active traders play in ensuring that prices quickly reflect new information.

Abstract:
We analyze mutual fund industry selectivity - the ability of funds to skillfully allocate assets across industries. We estimate that industry selection influences mutual fund performance about as much as individual stock selection. We find that persistence across the full range of performance deciles is attributable to industry selection. After removing industry effects from gross mutual fund returns, we find that the performance of poorly performing funds strongly reverses. We also find that, unlike individual-stock-selection ability, industry selectivity is not subject to diminishing returns to scale.

mutual funds, persistence, industry selection

Abstract:
This paper uses daily returns to examine how mutual funds modify their risk during the last several months of a year based on their performance during the first several months of the year. Relative to monthly data, daily returns provide much more efficient estimates of fund volatility, yielding vastly different inferences about the behavior of fund managers. In particular, monthly results consistent with a tendency for year-to-date underperformers to increase their risk levels relative to better performing funds disappears with daily data. This indicates that results previously attributed to managerial behavior are more likely an artifact of inefficient monthly volatility estimates.

Abstract:
Using daily returns, we find that Bayesian alphas that incorporate fund expenses and a long history of factor returns predict future mutual fund Sharpe ratios significantly better than traditional measures. For investors who believe in managerial skill, Bayesian measures choose funds that subsequently outperform funds chosen by standard single- or four-factor alphas. For investors who are skeptical of managerial skill, Bayesian measures choose funds that subsequently outperform funds chosen by expenses. Over our entire sample period, we find that priors consistent with a moderate belief in managerial skill dominate the more extreme skeptical or diffuse prior beliefs. Since a model with diffuse prior beliefs in managerial skill best predicts actual fund cash flows, our results suggest that Bayesian alphas can help investors choose better performing funds.

Abstract:
Using new, survivorship-bias free data, we examine performance persistence in 6,260 institutional portfolios managed by 1,475 investment management firms between 1991 and 2004. Unlike retail mutual funds, persistence in winner domestic equity portfolios is significant and economically large for up to one year. Loser portfolios, conversely, do not persist. International portfolios exhibit similar patterns, and fixed income portfolios persist up to three years. We find that better-performing portfolios offer performance-based fees and most-favored-nation clauses more often, but also charge higher fees. The magnitude of fees is insufficient to eliminate excess returns. Top performers draw an influx of assets from plan sponsors, and in the year following such inflows, alphas sharply decline.

Abstract:
Theory suggests the most profitable way to exploit stock picking skill is to set up an investment fund, yet in practice buy-side and sell-side stock analysts coexist. We examine the relative merits of stock picks from institutional investors and brokerage analysts, and the extent to which institutions use sell-side analysts' recommendations. We find that sell-side analysts' recommendations are informative. Although mutual fund purchases significantly outperform their sales the difference, in performance is largely concentrated on the day of the trade. Mutual funds tend to trade in the direction of recommendation revisions but their trade direction is not incrementally informative.

Analyst, Mutual Funds

Abstract:
We analyze who plays a more important role in the success of a stock recommendation: the analyst or the brokerage firm that employs the analyst. Using a Bayesian methodology that models abnormal performance as the output of a Cobb-Douglas production function with analyst and broker inputs, we find evidence that the brokerage firm drives the announcement effect while the skill of the analyst ultimately determines the long-run success of a recommendation. Top-performing analysts who switch brokerage firms are likely to maintain their strong track records. Similarly, analysts who perform poorly continue to do so regardless of their employers. Our results hold over the sub-sample periods that surround the sell-side analyst reforms of 2002.

Analyst, Brokerage Firm, Recommendation, Bayesian Econometrics, Conflict of Interest

Abstract:
I use daily mutual fund returns to shed new light on the question of whether or not mutual fund managers are successful market timers. Previous studies find that funds are unable to time the market return. I study funds? ability to time market volatility. I show that volatility timing is an important factor in the returns of mutual funds and has led to higher risk-adjusted returns. The returns of surviving funds are especially sensitive to market volatility; those of nonsurvivors are not.

Abstract:
Results of recent research indicate small investor sentiment, as measured by the change in the discount on closed-end funds, is an important factor in the return-generating process for common stocks. We find no evidence of it being an important factor in the return-generating process. We next examine its impact on expected returns and whether one set of firms with high sensitivity to this factor, closed-end funds, offers, and can be expected to offer a higher expected return. Our findings do not support small investor sentiment as a priced factor, either in common stocks or closed-end funds.

Abstract:
We document a positive relation between mutual fund performance and managers' willingness to take big bets in a relatively small number of stocks. Focused managers outperform their more broadly diversified counterparts by approximately 30 basis points per month, or roughly 4% annualized. The results hold for mimicking portfolios based on fund holdings as well as when returns are measured net of expenses. Concentrated managers outperform precisely because their big bets outperform the top holdings of more diversified funds. The evidence suggests that investors may enhance performance by diversifying across focused managers rather than by investing in highly diversified funds.