Pessimistic Fund Managers

Abstract

This paper examines the predictive power of investment managers’ sentiment revealed in their letters to shareholders for their future performance, using closed-end funds (CEFs) as a laboratory. We find that pessimistic tone in managers’ letters to shareholders predicts superior future risk-adjusted returns. The result is not driven by the 2008-2009 financial crisis and the subsequent recovery. We find that pessimistic CEFs are more likely to initiate profitable stock trades prior to stocks’ earnings announcements. Our result is consistent with the reference-dependent effort provision theory: fund managers exert more effort when they feel at a loss relative to their reference points.

Keywords: Textual analysis, Fund disclosure, Fund performance, Reference-dependent effort provision

JEL Classification: M40, G14, G19