Does MAX Matter for Mutual Funds?

Abstract

We examine the lottery characteristics of mutual funds. We proxy for lottery characteristics using past extreme daily returns within a month, or MAX. We find that high MAX funds underperform both in portfolio sorts and cross-sectional regression tests. This result suggests that the MAX effect documented for individual stocks is also present within diversified portfolios of mutual funds. Using mutual fund flows, we also show direct evidence of strong retail, but not institutional, investor demand for high MAX funds. Overall, our findings indicate that retail investors exhibit demand for lottery-like funds that are likely to suffer from future underperformance.

Keywords: Mutual fund flows and performance, MAX, lottery preferences, skewness

JEL Classification: G11, G23