Investor Irrationality and the Role of Distribution Channels in Chinese Index Fund Selection
30 Pages Posted: 22 Jan 2019
Date Written: January 21, 2019
We examine the impact of distribution channels on fund selection in China. We show that fund selection in plain vanilla passive investment products in the Chinese context is complicated through strategic interactions between fund companies and their distribution channels. We ﬁnd, contrary to common assumption, Chinese index funds are not homogeneous in structure and performance. There is signiﬁcant tracking error and performance dispersion between products of seeming identical objectives. Our results show that, Chinese retail investors, facing high search costs, make suboptimal investment decisions and rely heavily on distribution channels for selecting funds. We also uncover strong opportunistic market timing characteristics amongst retail investors of index funds, which is not present with institutional investors. In aggregate, we document signiﬁcant ineﬃciency in Chinese mutual fund market and social welfare loss associated with high search cost.
Keywords: Chinese mutual fund market, index funds, search cost, investor behaviour, distribution channels
JEL Classification: G14, G15, G23
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