Asset Fire Sales, Liquidity Provision, and Mutual Fund Performance

Abstract

This paper identifies managerial ability by looking at extreme liquidity events. Forced trades by distressed funds – those that are experiencing severe money outflows – generate temporary downward price pressure on securities held in common by these funds and therefore create trading opportunities for other investors. This paper shows that some fund managers are able to consistently identify and purchase these fire-sale stocks and that they benefit from providing liquidity to distressed funds. Moreover, these managers exhibit overall investment skills beyond identifying fire-sale stocks, which lead to superior performance for the rest of their portfolios. The performance results remain robust after adjusting for risk and controlling for fund attributes, such as fund flows and turnover.

Keywords: Liquidity Provision, Mutual Fund Performance, Financial Distress, Price Pressure

JEL Classification: G10, G14, G23