Mismarking Fraud in Mutual Funds

Abstract

We study potential fraudulent mismarking of newly purchased odd lot and two classes of round lot positions in structured products. Such mismarking artificially inflates net asset values and overstates cumulative returns. Applied to mutual funds launched after January 2010, a simulation-tested mismarking fund filter identifies 12 Highly Questionable funds managing $75 billion. The performance of these funds matches closely the predicted pattern of mismarking: extremely high alpha and skewness, particularly immediately after launch. We show that structured-product mismarking can seriously inflate return-since-inception metrics. We also provide evidence consistent with return smoothing in at one quarter of the sample structured product funds. The inflated performance metrics benefit fund managers through significantly higher Morningstar ratings and asset growth, but cause material losses to later investor cohorts.

Keywords: mutual fund performance, structured products, odd lot, mismarking

JEL Classification: G21, G23, M41