Algorithmic Trading and Mutual Fund Performance

Abstract

We examine the effects of algorithmic trading (AT) on the US mutual fund industry and find that funds holding stocks with higher AT intensity have lower holdings returns and higher interim trading profits (return gap). This effect survives controls of effective spread and execution shortfall. Our results suggest that AT’s effect on funds is via the trading channel rather than funds’ stock selection abilities. AT’s positive effects of enhanced market quality on fund performance dominates its negative predatory trading influence. Using exchange automation as an instrument, we find evidence suggesting the effect of AT on the return gap is causal.

Keywords: algorithmic trading; high frequency traders, mutual funds; performance; retrun gap

JEL Classification: G11; G22