Past Performance May Be an Illusion: Performance, Flows, and Fees in Mutual Funds
Critical Finance Review, Forthcoming
56 Pages Posted: 30 Oct 2012 Last revised: 22 Dec 2014
Date Written: September 15, 2014
Mutual funds report performance in the form of a holding period return (HPR) over standardized horizons. Changes in HPRs are equally influenced by new and previously reported stale returns which enter and exit the horizon. Investors appear unable to differentiate between the joint determinants, reacting with equal strength to both signals. Stale performance chasing is amplified for funds which promote performance via advertising and is more pronounced during periods of uncertainty in financial markets. Fund managers exploit this behavior by preferentially timing fee increases to align with periods of heightened investor demand resulting from stale performance chasing.
Keywords: Limited attention; Behavioral finance; Investor psychology; Capital markets; Horizon effects; Mutual fund fee-setting
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