The Determinants of Investment Flows: Retail versus Institutional Mutual Funds

Abstract:     
Over the past decades, the mutual fund industry has grown considerably. Moreover, since the early 1990s, a new class of so-called institutional funds has emerged. In contrast to retail funds that focus on regular individuals, institutional funds primarily target institutional investors such as corporations, non-profit organizations, endowments, foundations, municipalities, pension funds, and other large investors, including wealthy individuals. As a result, the typical retail fund investor differs noticeably from the typical institutional fund investor in his level of financial sophistication, investment objectives, and search costs (Alexander et al. 1998; Del Guercio and Tkac 2002; Palmiter and Taha 2008). Consequently, the two types of investors are likely to differ in terms of the criteria on which they base their investment decisions, and the resultant investment flow patterns of retail and institutional funds are likely to differ as well.

In this paper I compare fund selection criteria for retail and institutional mutual funds’ investors. I find that clients of institutional mutual funds use more quantitatively sophisticated criteria, such as risk-adjusted return measures and tracking error, than investors of retail mutual funds do. In line with momentum trading literature, I show that institutional investors demonstrate stronger momentum driven behavior. Additionally, the results indicate that relative performance of a fund with respect to a benchmark is an important criterion in fund selection process for investors of both types of funds. Finally, I provide evidence that the convex form of flow-performance relationship, documented by existing literature, is driven mostly by retail funds.

Number of Pages in PDF File: 38

Keywords: mutual funds, institutional investors, retail investors, institutional funds, retail funds, investment decisions, fund flows, performance evaluation

JEL Classification: G02, G11, G23

working papers series