Do Mutual Funds Walk the Talk? A Textual Analysis of Risk Disclosure by Mutual Funds

42 Pages Posted: 22 Mar 2021 Last revised: 20 Jul 2021

See all articles by Jinfei Sheng

Jinfei Sheng

University of California, Irvine - Paul Merage School of Business

Nan Xu

Nankai University - School of Finance

Lu Zheng

University of California, Irvine - Paul Merage School of Business

Date Written: July 8, 2021

Abstract

Do risk disclosures by mutual funds reflect funds’ actual investment risks? Using textual analysis, we examine risk disclosures in funds’ summary prospectuses to determine whether funds do accurately disclose their risks. We first document the types of risks disclosed by funds and study the relation between fund-disclosed risks and risk factors documented in academic studies. We find that most disclosed risks can be linked to meaningful and well-known academic risk factors. In our main tests, we develop fund-level measures to evaluate the informativeness of funds’ risk disclosure, including risk coverage, conciseness, and uniqueness. Our findings suggest that disclosed risks, in general, reflect a large proportion of funds’ investment risks but with substantial cross-fund heterogeneity. Younger funds, larger funds, riskier funds, funds with higher expense ratios, and funds with inferior performance tend to make more comprehensive disclosures. Interestingly, we find that funds tend to overdisclose risks; half of the disclosed risks are not significant in explaining the variations in fund returns. Further tests show that less skilled funds tend to disclose more. However, new money flows are not related to risk coverage. Overall, this paper provides novel evidence on the informativeness of risk disclosure in the summary prospectus.

Keywords: Mutual funds, risk, disclosure, textual analysis, information, prospectus, performance, flow

JEL Classification: G11, G23

Suggested Citation

Sheng, Jinfei and Xu, Nan and Zheng, Lu, Do Mutual Funds Walk the Talk? A Textual Analysis of Risk Disclosure by Mutual Funds (July 8, 2021). Available at SSRN: https://ssrn.com/abstract=3757077 or http://dx.doi.org/10.2139/ssrn.3757077

Jinfei Sheng

University of California, Irvine - Paul Merage School of Business ( email )

4291 Pereira Drive
Irvine, CA 92697
United States

HOME PAGE: http://sites.google.com/site/shengjinfei/

Nan Xu

Nankai University - School of Finance ( email )

38 Tongyan Road, Jinnan District
Tianjin, Tianjin 300350
China

Lu Zheng (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Paul Merage School of Business
Irvine, CA California 92697-3125
United States
9498248365 (Phone)

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