Informed Trading of Mutual Funds: Evidence From Fund-Underwriter Relationships

Abstract

This paper investigates whether the relationship between investment banks and their affiliated
funds helps the funds deliver superior performance due to the information advantage or whether
it costs the funds due to the conflict of interest. Using firms with class-action lawsuits, I examine
whether underwriter-affiliated funds can avoid a potential economic loss from the underwriting
clients’ fraudulent activities. Consistent with the information advantage hypothesis, I find that
affiliated funds reduce their stakes in underwritten firms before the disclosure of the firms’
misconduct. Additionally, I find that significant selling activity by the affiliated funds can predict
the outcome of a potential lawsuit.

Keywords: Underwriting Relationships, Mutual Funds, Information Sharing, Securities Class-Action Lawsuits

JEL Classification: G23, G24, K22