The Economic Impact of Mutual Fund Investor Behaviors
59 Pages Posted: 29 Apr 2018
Date Written: April 10, 2018
This study analyzes how the determinants of mutual fund investor cash flows have changed over time, and the associated impact on investor returns. Using data from 1992-2016 we find that investor return-chasing behavior essentially disappeared starting in 2011. Investor flows have become more sensitive to expenses, past risk and alpha. Investors are paying more attention to fund characteristics that matter (e.g. risk, alpha and expenses), and less attention to characteristics that don’t (e.g. past returns). Nevertheless, the average investor dollar-weighted return is about 1.2% below the average buy-and-hold return in their underlying mutual fund nearly every year in our sample, suggesting consistently poor timing ability over the entire period. We decompose the economic impact of investor behaviors on investor returns and find that investors’ focus on alpha is actually more detrimental than their previous focus on past returns. Investors do benefit from choosing high-alpha funds (smart money), but poorly time their cash flows by investing in those funds after periods with the highest realized alphas (dumb money). The dumb money effect dominates the smart money effect for the simple reason that at the fund level, past alphas are strongly and negatively correlated with future alphas. Although past alphas are positively correlated to future alphas in the pooled cross-section of mutual fund data, this result does not hold at the individual fund level, which is the level where most mutual fund customers invest. Overall, our results suggest that mutual fund investors know that alpha is important, but have not yet learned how to effectively integrate this knowledge into their investment decisions.
Keywords: Mutual Fund Investor Behavior, Return-chasing, Smart Money, Dumb Money, Alpha Persistence
JEL Classification: G11, G23
Suggested Citation: Suggested Citation