The Shrouded Business of Style Drift in Active Mutual Funds

31 Pages Posted: 8 Jul 2020

Date Written: February 8, 2020

Abstract

This study investigates the motivation and performance consequence of intentional style drift in an exclusively in-house fund management industry in China. With style drift, fund investors are exposed to investment portfolio outside their risk-return preference but are generally unaware that their risk and return expectations are disrupted, and the functioning of the fund market undermined. Our study provides evidence for the first time about the incentive that motivates style drift behavior. We find that style drift increases a fund’s subsequent net inflows, thus affirming the maximization of AUM-linked compensation as the motivation for fund manager’s style drift behavior. We also find that larger funds have greater incentive to drift. We demonstrate that style drift behavior interferes with the picking of quality stocks to deliver fund performance for fund investors. Style drift as an unobserved risk behavior harms fund investor interest and undermines market integrity.

Keywords: Style drift, Mutual funds, Holdings-based analysis, Stock picking, Compensation design, Risk-taking incentive

JEL Classification: G11, G14, G23, N25

Suggested Citation

Chua, Kim Pei Angeline and Tam, On Kit, The Shrouded Business of Style Drift in Active Mutual Funds (February 8, 2020). Journal of Corporate Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3626137

Kim Pei Angeline Chua (Contact Author)

RMIT University ( email )

Swanston Academic Building
Level 11, 445 Swanston Street
Melbourne, 3000
Australia

On Kit Tam

RMIT University ( email )

College of Business
Swanston Street
Melbourne, Victoria 3000
Australia

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