Mutual Fund Portfolio Choice in the Presence of Dynamic Flows

56 Pages Posted: 18 Nov 2002 Last revised: 28 Sep 2008

See all articles by Ron Kaniel

Ron Kaniel

University of Rochester - Simon Business School; CEPR

Julien Hugonnier

Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: February 13, 2008

Abstract

We analyze the implications of dynamic flows on a mutual fund manager's portfolio decisions. In our model, a myopic investor is allowed to dynamically allocate capital between a riskless asset and an actively managed mutual fund who charges fraction of fund fees. The presence of dynamic flows induces flow hedging portfolio distortions on the part of the fund, even though the investor is myopic. Our model predicts a positive relationship between a fund's proportional fee rate and its volatility. This is a consequence of higher fee funds holding more extreme equity positions. While both the fund portfolio and the investor's trading strategy depend on the proportional fee rate, the equilibrium value functions do not. Implications related to the measured performance-fund flow relationship and its dependence on the level of the fee rate are derived. Finally, we show that our results hold even if the investor is allowed to directly trade some, but not all, of the risky securities.

JEL Classification: G11, G12, G13, G23, D81

Suggested Citation

Kaniel, Ron and Hugonnier, Julien, Mutual Fund Portfolio Choice in the Presence of Dynamic Flows (February 13, 2008). Swiss Finance Institute Research Paper. Available at SSRN: https://ssrn.com/abstract=343720 or http://dx.doi.org/10.2139/ssrn.343720

Ron Kaniel (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

HOME PAGE: http://rkaniel.simon.rochester.edu

CEPR ( email )

London
United Kingdom

Julien Hugonnier

Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL Dorigny
Extranef
Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/hugonnier

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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