Follow the Leader: Peer Effects in Mutual Fund Portfolio Decisions

Abstract:     
Mutual fund portfolio decisions depend on previous trades of other funds with outstanding past performance: funds mimic the mutual fund industry leaders. Controlling for other factors, for each dollar leaders invest in a given stock, the follower funds invest 15 to 30 cents in the subsequent quarter. Funds with poor past performance mimic more than funds with moderate performance; there is also some evidence that small and young funds mimic more than old and large ones. Leader trades that are likely to convey more information (more extreme trades, trades in more opaque stocks) elicit stronger responses. Mimicking makes economic sense: portfolios based on past trades of the leaders deliver significant 3 and 4 factor alphas of the order of 0.35% per month. Characteristics-matched returns indicate that a large portion of this abnormal performance can be attributed to stock momentum, which suggests a possible link between follow the leader behavior and momentum.

Number of Pages in PDF File: 45

Keywords: mutual funds, portfolio choice, information acquisition, momentum

JEL Classification: G11, G23

working papers series