We study capital allocations to managers with two mutual funds, and show that investors learn about managers from their performance records. Flows into a fund are predicted by the manager's performance in his other fund, especially when he outperforms and when signals from the other fund are more useful. In equilibrium, capital should be allocated such that there is no cross-fund predictability. However, we find positive predictability, particularly among underperforming funds. Our results are consistent with incomplete learning: while investors move capital in the right direction, they do not withdraw enough capital when the manager underperforms in his other fund.
In a linear flow-performance regression, which includes past four-factor alphas of both funds as independent variables, the sensitivity to the other fund’s performance is about 17% of the sensitivity to the fund’s own performance. This result is not explained by the fact that the two funds come from the same family. We control for family fixed effects and the presence of a star fund, which can create spillover flows to other funds in the family
How to avert fragility in open-end mutual funds? In recent years, markets have observed an innovation that changed the way open-end funds are priced. Alternative pricing rules (known as swing pricing) adjust funds’ net asset values to pass on funds’ trading costs to transacting shareholders. Using unique data on investor-level transactions in U.K. corporate bond funds, we show that swing pricing eliminates the first-mover advantage arising from the traditional pricing rule and significantly reduces outflows during market stress. Swing pricing also reduces concavity in the flow-performance relationship and dilution in fund performance.
Individuals increasingly buy mutual funds via online platforms, whose “best-buy” recommendations heavily influence flows. As intermediaries of mutual funds, platforms provide none of the unobservable interaction or intangible benefits of brokers, and so allow clean tests of the determinants, influence, and value of their fund recommendations. Using unique U.K. data, we find that platforms favor “own-brand” funds and those paying them a higher commission share. Investors discount own-brand recommendations, but not those paying high commission shares (which were not observable in the United Kingdom). A regulatory ban on commission sharing lowered costs and improved the informativeness of platform recommendations.
Using novel data on engagements of the Big Three with individual firms, we find evidence that the Big Three focus their engagement effort on large firms with high CO2 emissions in which these investors hold a significant stake.
We obtain carbon emission data for a wide cross-section of firms between 2005 and 2018. We complement these data with information on Big Three engagements with individual firms, which we hand-collect from recent public disclosures of these fund sponsors. Our data indicate that, on average, these large funds engage annually with a number of firms (for example, from 7/1/2018 to 6/30/2019 BlackRock held personal meetings with directors and executives of 1,458 firms). When we explore the determinants of the probability of such engagements, we find corroborating evidence that firms with higher CO2 emissions are more likely to be the target of Big Three engagements. We also find that the Big Three focus their engagements on large firms (i.e., firms with a potentially larger effect on global carbon emissions) and on firms in which these large investors have a more substantial stake (i.e., firms in which the Big Three are more influential).
We find a negative and significant association for MSCI firms; one standard deviation increase in Big Three holdings in a given firm is associated with a reduction of approximately 2% in corporate CO2 emissions.
Injury rates increase with leverage and negative cash flow shocks, and decrease with positive cash flow shocks. We show that firm value decreases substantially with injury rates. Our findings suggest that investment in worker safety is an economically important margin on which firms respond to financing constraints.
As we lack exogenous variation in financial resources with which to completely isolate the effect of financing on injuries, we employ several empirical strategies. Each approach produces evidence pointing toward increased financial resource availability leading to fewer injuries, suggesting that financing constraints impair investment in safety. While any one piece of evidence is open to alternative interpretations, the evidence taken together is difficult to reconcile with any specific alternative.
We show that experiencing transient happiness is associated with flows to mutual funds in the following month. When considering funds' investment style, heterogeneous effects arise. Happiness and perceived well-being correspond with flows to growth funds but not value funds.
By interviewing at least 500 individuals each day, Gallup provides a representative, ongoing assessment of Americans’ health.5 To measure positive emotion, respondents are asked “Did you experience happiness during a lot of the day yesterday?” Gallup aggregates the responses to reflect the proportion of individuals who experience happiness on a given day. We use this measure, Happiness, as our primary measure of transient emotion because happiness is driven by the frequency of positive affect.
We investigate the relation between tax burdens and mutual fund performance from both a theoretical and an empirical perspective. The theoretical model introduces heterogeneous tax clienteles in an environment with decreasing returns to scale and shows that the equilibrium performance of mutual funds depends on the size of the tax clienteles.
Our empirical results show that the performance of U.S. equity mutual funds is related to their tax burdens. We find that tax-efficient funds exhibit not only superior after-tax performance, but also superior before-tax performance due to lower trading costs, favorable style exposures, and better selectivity.
Using manager compensation disclosure and intra-family manager cooperation measures, we create indices of family-level competitive/cooperative incentives. Families that encourage cooperation among their managers are more likely to engage in coordinated behavior (e.g., cross-trading, cross-holding) and have less volatile cash flows.
Families with competitive incentives generate higher performing funds, a higher fraction of "star" funds, but greater performance dispersion across funds.
The six competitive incentive variables include a solo-managed fund indicator; three indicator variables of whether or not a manager’s bonus was based on fund performance, fund revenue, or paid in fund shares; a Coles incentive rate variable measuring the concavity of the fund fee; and the range of manager ownership of a fund. The six cooperative incentives variables include: a team-managed fund indicator, the average ratio of the number of managers per fund, and a measure of the degree of manager interconnection within the family; two indicator variables of whether or not the manager’s bonus is paid in advisor equity or based on advisor level activities of the manager; and an indicator variable of whether or not the fund’s fee is based on the assets or performance of other funds in the family.
We find that actively managed funds are more active and charge lower fees when they face more competitive pressure from low-cost explicitly indexed funds. A quasi-natural experiment using the exogenous variation in indexed funds generated by the passage of pension laws supports a causal interpretation of the results. Moreover, the average alpha generated by active management is higher in countries with more explicit indexing and lower in countries with more closet indexing. Overall, our evidence suggests that explicit indexing improves competition in the mutual fund industry.
The Investment Company Act of 1940 restricts interfund lending and borrowing within a mutual fund family, but families can apply for regulatory exemptions to participate in such transactions. We find that the monitoring mechanisms and investment restrictions influence the family’s decision to apply for the interfund lending programs. We document several benefits of such programs for equity funds. First, participating funds reduce cash holdings and increase investments in illiquid assets. Second, fund investors exhibit less run-like behavior. Third, it helps mitigate asset fire sales after extreme investor redemptions. Offsetting these benefits, money market funds in participating families experience investor outflows.
Pressure from institutional money managers to generate profits in the short run is often blamed for corporate myopia. Theoretical research suggests that money managers’ short term focus stems from their career concerns and greater fund transparency can amplify these concerns. Using a difference-in-differences design around a regulatory shock that increased transparency about fund managers’ portfolio choices, we examine whether increased transparency encourages myopic corporate investment behavior.
As fund investors gain access to more frequent and reliable information on fund managers’ stock picks, fund managers may focus excessively on holding stocks that appear as “winners” in these short-term disclosures. Consequently, frequent portfolio disclosures can reduce the fund manager’s tolerance for having investee firms in the portfolio that pursue policies that will generate value in the long run, but can appear as “poor” stock picks in short-term portfolio disclosures. This increased short-term focus of fund managers can create pressure on managers of investee firms to behave myopically.
In 2004, altered the reporting frequency of portfolio holdings by mutual fund managers from semi-annual to quarterly reporting. We examine how the change in firm-level innovation (first difference) around the SEC regulation varies with the ownership levels of actively managed funds (second difference) that were forced to increase their disclosure frequency.
Using patent-based measures of firm-level innovation, we find evidence of a significantly larger decline in innovation following the regulation for firms with high fund ownership. The decline in innovation output is economically significant: our estimates suggest that firms with above-median ownership on average file nearly one fewer (citation-weighted) patent compared to firms with below median ownership following the SEC regulation.
We provide a rationale for window dressing where investors respond to conflicting signals of managerial ability inferred from a fund’s performance and disclosed portfolio holdings. We contend that window dressers take a risky bet on their performance during a reporting delay period, which affects investors’ interpretation of the conflicting signals and hence their capital allocations. Conditional on good (bad) performance, window dressers benefit from higher (lower) investor flows as compared to non-window dressers. Window dressers also have poor past performance, possess little skill, and incur high portfolio turnover and trade costs, characteristics which in turn result in worse future performance.
We examine the relation between mutual fund votes on shareholder executive compensation proposals and pension-related business ties between fund families and the firms. In unconditional tests, we find that fund families support management when they have pension ties to the firm. We find no relation when we stratify by fund family in conditional tests, which suggests that fund families with pension ties vote with management at both client and non-client firms. We confirm this result in an analysis of non-client firms. Overall, our results suggest that pension related business ties influence fund families to vote with management at all firms.
Many investors purchase open-end mutual funds through intermediaries, paying brokers and financial advisors for fund distribution and advice via alternative sale charge fee structures. We argue that the fee structure choice (front-end back-end load) reveals valuable information about investors horizon. That allows portfolio managers to manage liquidity more efficiently, and to improve performance by timely matching their investment choices to the underlying investment horizon of their investors. Mutual funds with more committed capital hold shares longer, invest in more illiquid stocks, and take advantage of securities with slow-moving arbitrage opportunities, i.e., fire-sale stocks, innovative stocks. This evidence reveals an overlooked shadow cost of disintermediation in the mutual fund industry.
Neil Woodford, whose investment empire is in serious trouble as clients have fled and U.K. regulators have launched an investigation. Mr. Woodford built a reputation for making winning, contrarian bets on large, unloved stocks over 25 years at U.S. company Invesco Perpetual. He avoided internet companies in the dot-com bust and steered clear of banks ahead of the 2008 financial crisis. He struck out on his own in 2013. Since then, Mr. Woodford’s investment focus shifted toward unlisted stocks in companies with unproven technologies or pharmaceutical products. The U.K. trust sector in general has average leverage of 9% of net asset value. The Woodford Patient Capital Trust runs with leverage close to its limit of 20% net asset value.