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Abstract:
We relate the performance of mutual fund trades to their motivation. A fund manager who buys stocks when there are heavy investor outflows is likely to be motivated by the belief that the stocks are significantly undervalued. In contrast, when there are heavy inflows, the manager is likely to be motivated to work off excess liquidity by buying stocks. Our analysis reveals that managers making purely valuation-motivated purchases substantially beat the market but are unable to do so when compelled to invest excess cash from investor inflows. A similar, but weaker, pattern is found for stocks that are sold. (JEL G11, G29)

Abstract:
We relate the performance of mutual fund trades to their motivation. A fund manager who buys stocks when there are heavy investor outflows is likely to be motivated by the belief that the stocks are significantly undervalued. In contrast, when there are heavy inflows the manager is likely to be motivated to work off excess liquidity by buying stocks. Our analysis reveals that managers making purely valuation-motivated purchases substantially beat the market, but are unable to do so when compelled to invest excess cash from investor inflows. A similar, but weaker, pattern is found for stocks that are sold.

Abstract:
Firms that engage in the simultaneous, or "side-by-side", management of mutual funds and hedge funds have a fiduciary duty to each fund's investors to make portfolio decisions and to execute trades in the most favorable way. This fiduciary duty is put to the test, however, when side-by-side management firms can increase fee income by strategically transferring performance from the mutual funds to the hedge funds they oversee. Our empirical evidence proves consistent with such favoritism. The reported returns of side-by-side mutual funds are significantly less than those of similar mutual funds run by firms that do not also manage hedge funds. A decomposition of reported returns into holdings-return and return-gap components and return-persistence tests also suggest favoritism. Finally, examining a potential wealth transference mechanism, we find evidence consistent with side-by-side mutual funds getting less of a contribution to performance from IPO underpricing than matched unaffiliated mutual funds.

mutual funds, hedge funds, side-by-side arrangements, institutional investors

Abstract:
This study examines whether the disposition effect influences the trades and performance of U.S. equity mutual funds. Compared to previous studies that find overwhelming evidence of the disposition effect in the trades of retail investors, this study documents that the disposition effect has a much weaker influence on the trades of mutual funds. On average, mutual funds appear to realize losses more readily than gains. However, we observe a great deal of heterogeneity among them with respect to the realization of gains and losses, as about 36 percent of the sample funds exhibit a propensity to realize gains more readily than losses. The observed tendency for these funds does not appear to be driven by a contrarian style and it appears to be somewhat consistent through time, making the disposition effect its most likely explanation. The disposition effect influences portfolio characteristics, with portfolios of high disposition funds exhibiting positive loadings on the book-to-market factor and negative loadings on the momentum factor. Relating the disposition effect to fund performance in the cross-section, we find that the disposition effect is negatively related to fund performance in an economically and statistically significant way.

Mutual funds, disposition effect

Abstract:
We study the dispersion of month-end valuations placed on identical corporate bonds by different mutual funds. Such dispersion is related to bond-specific characteristics associated with liquidity and market volatility. Tests suggest that FINRA’s transparency-enhancing TRACE system has increased the precision of corporate bond valuation to the benefit of investors. Other tests reveal the marking patterns of a minority of funds to be associated with return smoothing behavior. However, funds with explicit, self-disclosed marking standards do not appear to smooth returns. These findings suggest that the SEC should require every fund to commit to an explicit marking standard in its prospectus.

mutual funds, bonds, valuation, fair value

Abstract:
We examine the choices made by S&P 500 index fund investors. Choosing the best index fund should not be particularly difficult for investors because relative returns among these funds are largely decided by management expenses that are easy to predict. Surprisingly, a group of investors fail to recognize that some index funds have excessively high cost structures, given the low cost of managing an index fund, and thus offer uncompetitive returns. We call this observation the Index Fund Rationality Paradox because it conflicts with the belief that index fund investors are making a rational choice in their ‘type of fund’ decision. In our analysis of this paradox, we find it important to make a distinction between retail and institutional index funds. Accounting for newly introduced S&P 500 funds and using a sample period that extends to the end of 2006, we show that investors as a class have made smarter choices in recent years such that the Index Fund Rationality Paradox has become less of an issue over time. Nonetheless, we identify a small group of investors that seem to be unduly influenced by brokers and financial advisors and we document that these arguably naïve investors are largely responsible for the remaining paradox.

Mutual funds, S&P 500 index