Equity Returns and the Fund Flow Sensitivity Premium

Abstract

We empirically identify stocks which make flows into mutual funds holding them more performance-sensitive, and show that fund managers dislike holding these stocks; these stocks earn positive abnormal returns of around 3.5% annually; and, the sensitivity premium has increased over time as the mutual fund sector has grown. Higher flow-performance sensitivity seems to be induced by small, hard-to-value stocks with low analyst coverage and less liquidity; but, abnormal returns to sensitive stocks are not subsumed by these underlying characteristics. Finally, falsification tests show that aversion to sensitive stocks is more related to managerial exposure to investor-driven flows, rather than liquidity-preference.

Keywords: Intermediaries and Asset Prices, Behavioral Finance, Mutual Funds, Investor Behavior, Portfolio Choice

JEL Classification: G02, G11, G23