Why Does Mutual Fund Performance Not Persist? The Impact and Interaction of Fund Flows and Manager Changes

Abstract

This paper investigates the reasons for the lack of long-term persistence in the investment performance of actively managed equity mutual funds. We document that the responses of investors, fund managers, and investment management companies to past performance affect future performance. Conditioning on fund flows and manager changes allows us to predict future performance of both past outperforming (winner) and past underperforming (loser) funds. Recent winner funds, experiencing neither high inflows nor a manager change, outperform by 3.60 percentage points based on risk-adjusted returns in the following year, relative to winner funds suffering from both effects. The performance of the worst performing funds experiencing both the replacement of the fund manager (internal governance) and high outflows (external governance) enjoys a subsequent increase of 2.40 percentage points in the following year, relative to loser funds not experiencing these effects. Among loser funds, in particular, both mechanisms appear to interact strongly.

Keywords: Mutual Funds, Performance Persistence, Fund Flows, Manager Turnover

JEL Classification: G28, G29, G32