Common Fund Flows: Flow Hedging and Factor Pricing
63 Pages Posted: 24 Apr 2020 Last revised: 7 Jun 2021
Date Written: May 31, 2021
Active mutual fund managers care about fund size, which is affected by common fund flows driven by macroeconomic shocks. Fund managers hedge against common flow shocks by tilting their portfolios toward low-flow-beta stocks. In equilibrium, common flow shocks earn a risk premium. A multi-factor asset pricing model similar to the ICAPM arises, even with all agents behaving myopically. Empirically, fund flows obey a strong factor structure with the common component earning a risk premium, and fund portfolios are, on average, tilted toward low-flow-beta stocks. This tilt increases in magnitude when flow-hedging motives strengthen following natural disasters and unexpected trade-war announcements.
Keywords: Mutual fund flows, Factor models, Heterogeneous agents, Financial intermediaries, Price impact, Uncertainty.
JEL Classification: G11, G12, G23
Suggested Citation: Suggested Citation