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

Abstract

Using textual analysis, we examine whether risk disclosures in funds’ summary prospectus reflect funds’ investment risks. We document the risks disclosed by funds and how they relate to academic risk factors. We then evaluate the relevance, conciseness and order of the risk disclosures. We find that disclosed risks explain about 50% of variations in fund returns; funds tend to overdisclose by reporting insignificant risks; the order of disclosure does not imply importance. We also find that funds improve their disclosure relevance after receiving SEC comment letters. We further explore the implications of risk disclosure for flow, risk taking and performance.

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

JEL Classification: G11, G23