How Do Bond Investors Measure Performance? Evidence from Mutual Fund Flows

Abstract

Which factor model do investors in corporate bonds use? We examine this question by tracking investors’ decisions to invest in actively managed corporate bond mutual funds with a revealed preference approach. Our main result is that all bond factor models are dominated by the simple Sharpe ratio. For all major corporate bond mutual fund styles, the Sharpe ratio explains fund flows better than alphas from bond factor models. Since the Sharpe ratio can be easily manipulated in bond markets, our findings have potentially severe implications for fund mangers as well as active traders and buy-and-hold corporate bond mutual fund investors.

Keywords: bond factor models, Sharpe ratio, bond mutual funds, investor flows, performance evaluation, flow-performance sensitivity

JEL Classification: G12, G11