Do Mutual Funds Walk the Talk? Evidence from Fund Risk Disclosure

Abstract

We examine the accuracy of mutual fund risk disclosure using the Risk Coverage Ratio (RCR), comparing the explanatory power of risks disclosed by a fund to that of all risks disclosed by all funds. Excluding market risk, the average fund RCR is 55%; RCR drops to 26% when we exclude information contained in fund names. RCR is positively related to flows from institutional investors. However, RCR correlates with lower future fund performance, suggesting costs associated with revealing private information. Notably, 56% of disclosed risks are insignificant, indicating overdisclosure. Funds improve the informativeness of risk disclosure after receiving SEC comment letters.

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

JEL Classification: G11, G23