Mutual Fund Performance and the Incentive to Generate Alpha
74 Pages Posted: 30 Sep 2011 Last revised: 17 Aug 2012
Date Written: August 14, 2012
To rationalize the well-known underperformance of the average actively managed mutual fund, we exploit the fact that retail funds in different market segments compete for different types of investors. Within the segment of funds marketed directly to retail investors, we show that flows chase risk-adjusted returns, and that funds respond by investing more in active management. Importantly, within this direct-sold segment, we find no evidence that actively managed funds underperform index funds. In contrast, we show that actively managed funds sold through brokers face a weaker incentive to generate alpha, and significantly underperform index funds.
Keywords: active management, index funds, investor heterogeneity, market segmentation, flow-performance
JEL Classification: G23, G14
Suggested Citation: Suggested Citation