Shadow of Loss: Mutual Fund Tail Behavior and Investor Flows

Abstract

We show that mutual fund investor flows are sensitive to past left-tail behavior of fund returns, even after controlling for fund performance and Morningstar ratings. This flow-tail behavior sensitivity is particularly pronounced for relatively recent tail episodes, during periods of stress, among investors who have experienced tail losses, and among retail and unsophisticated investors. Robust results are obtained from US equity mutual funds, individual household accounts, foreign mutual funds, bond funds, and different measures of tail behavior. After evaluating alternative explanations, we conclude that our findings are consistent with memory-based heuristics utilized in investor decision-making.

Keywords: Mutual fund, investor flow, tail behavior, memory, household investment

JEL Classification: G11, G12, G23