Changes in Mutual Fund Flows and Managerial Incentives
48 Pages Posted: 4 Dec 2009 Last revised: 2 Dec 2010
Date Written: December 8, 2009
I show that the flow-performance relationship for mutual funds, which was convex prior to 2000, is no longer convex. The expected marginal flow to high performing funds is lower when markets are highly volatile and when performance dispersion across funds is lower, and such variations contribute to the change in the shape. Consistent with these changes, I show that underperforming managers engage in less risk-shifting after 2000 and risk-shifting levels can be also explained by performance dispersion and market volatility. My results suggest that the flow-performance relationship can serve as a dynamic incentive contract - in which payoffs to good performers depend on whether investors perceive performance arising primarily from skills or from luck - and managers react to the incentives provided by the implicit compensation scheme.
Keywords: mutual funds, flow-performance relationship, risk shifting
JEL Classification: C14, G10, G20, G23
Suggested Citation: Suggested Citation