Mutual Funds' Competition for Investment Flows based on Relative Performance

24 Pages Posted: 26 Jun 2020

See all articles by Gu Wang

Gu Wang

Worcester Polytechnic Institute

Jiaxuan Ye

Worcester Polytechnic Institute

Date Written: June 12, 2020

Abstract

N mutual funds compete for fund flows based on relative performance over their average returns, by choosing between an idiosyncratic and a common risky investment opportunities. The unique constant equilibrium is derived in closed form, which imply that most funds decrease the investments in their idiosyncratic risky assets under competition, in order to lower the risk of the relative performance. It pushes all funds to herd and hurts their after-fee Sharp ratios. If a fund is sufficiently disadvantaged in the competition with poor investment opportunities, its investment can be excessively risky, and pushes all funds further away from their average. However, the performance of the disadvantaged funds can improve comparing to the case without competition and benefits the investors.

Keywords: Mutual Funds, Portfolio Choice, Relative Performance, Fund Flows, Equilibrium

JEL Classification: G11, G12

Suggested Citation

Wang, Gu and Ye, Jiaxuan, Mutual Funds' Competition for Investment Flows based on Relative Performance (June 12, 2020). Available at SSRN: https://ssrn.com/abstract=3609503 or http://dx.doi.org/10.2139/ssrn.3609503

Gu Wang (Contact Author)

Worcester Polytechnic Institute ( email )

100 Institute Road
Worcester, MA 01609
United States

Jiaxuan Ye

Worcester Polytechnic Institute

United States
01609 (Fax)

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