This paper studies the flows of funds into and out of equity mutual funds. Consumers base their fund purchase decisions on prior performance information, but do so asymmetrically, investing disproportionately more in funds that performed very well the prior period. Search costs seem to be an important determinant of fund flows. High performance appears to be most salient for funds that exert higher marketing effort, as measured by higher fees. Flows are directly related to the size of the fund’s complex as well as the current media attention received by the fund, which lower consumers ’ search costs. ALTHOUGH MUCH ACADEMIC RESEARCH on mutual funds addresses issues of performance measurement and attribution, we can learn more from this industry than whether fund managers can consistently earn risk-adjusted excess returns. Researchers studying funds have shed light on how incentives affect fund managers ’ behavior, 1 how board structure affects oversight activities, 2 and how scale and scope economies affect mutual fund costs and fees. 3 More generally, the fund industry is a laboratory in which to study the actions of individual investors who buy fund shares. In this paper, we study the flows of funds into and out of individual U.S. equity mutual funds to better understand the behavior of households that buy funds and the fund complexes and marketers that sell them.

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Considerable attention has recently been given to general equilibrium models of the pricing of capital assets. Of these, perhaps the best known is the mean-variance formulation originally

We develop a simple rational model of active portfolio management that provides a natural benchmark against which to evaluate observed relationship between returns and fund flows. Many effects widely regarded as anomalous are consistent with this simple explanation. In the model, investments with active managers do not outperform passive benchmarks because of the competitive market for capital provision, combined with decreasing returns to scale in active portfolio management. Consequently, past performance cannot be used to predict future returns, or to infer the average skill level of active managers. The lack of persistence in actively managed returns does not imply that differential ability across managers is nonexistent or unrewarded, that gathering information about performance is socially wasteful, or that chasing performance is pointless. A strong relationship between past performance and the flow of funds exists in our model: indeed, this is the market mechanism that ensures that no predictability in performance exists. Choosing parameters to match the flow-performance relationship and survivorship rates, we find these features of the data are consistent with the vast majority (80%) of active managers having at least

We use a new database to perform a comprehensive analysis of the mutual fund industry. We find that funds hold stocks that outperform the market by 1.3 percent per year, but their net returns underperform by one percent. Of the 2.3 percent difference between these results, 0.7 percent is due to the underperformance of nonstock holdings, whereas 1.6 percent is due to expenses and transactions costs. Thus, funds pick stocks well enough to cover their costs. Also, high-turnover funds beat the Vanguard Index 500 fund on a net return basis. Our evidence supports the value of active mutual fund management. DO MUTUAL FUND MANAGERS WHO actively trade stocks add value? Academics have debated this issue since the seminal paper of Jensen ~1968!. Although some controversy still exists, the majority of studies now conclude that actively managed funds ~e.g., the Fidelity Magellan fund!, on average, underperform their passively managed counterparts ~e.g., the Vanguard Index 500 fund!. 1 For example, Gruber ~1996! finds that the average mutual fund underperforms

We document strong positive correlation between changes in institutional ownership and returns measured over the same period. The result suggests that either institutional investors positive feedback trade more than individual investors or institutional herding impacts prices more than herding by individual investors. We find evidence that both factors play a role in explaining the relation. We find no evidence, however, of return mean-reversion in the year following large changes in institutional ownership -- stocks institutional investors purchase subsequently outperform those they sell. Moreover, institutional herding is positively correlated with lag returns and appears to be related to stock return momentum. 1 "Herding" (a group of investors trading in the same direction over a period of time) and "feedback trading" (correlation between herding and lag returns) have the potential to explain a number of financial phenomena, e.g., excess volatility, momentum, and reversals in stoc...

We investigate the effect of scale on performance in the active money management industry. We first document that fund returns, both before and after fees and expenses, decline with lagged fund size, even after adjusting these returns by various performance benchmarks. We then explore a number of potential explanations for this relationship. We find that this relationship is most pronounced among funds that have to invest in small and illiquid stocks, which suggests that the adverse effects of scale are related to liquidity. Controlling for its size, a fund’s performance actually increases with the asset base of the other funds in the family that the fund belongs to. This suggests that scale need not be bad for fund returns depending on how the fund is organized. Finally, we explore the idea that scale erodes fund performance because of the interaction of liquidity and organizational diseconomies.

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We investigate the value of active mutual fund management by examining the stockholdings and trades of mutual funds. We find that stocks widely held by funds do not outperform other stocks. However, stocks purchased by funds have significantly higher returns than stocks that are sold—this is true for large stocks as well as small stocks, and for value stocks as well as growth stocks. Moreover, growth-oriented funds exhibit better stockselection skills than income-oriented funds, especially in picking large growth stocks. Finally, funds trading more frequently have, at best, marginally better stock-selection skills than funds that trade less often. The Value of Active Mutual Fund Management: An Examination of the Stockholdings and Trades of Fund Managers I.

Mutual fund managers may decide to deviate from a well-diversified portfolio and con-centrate their holdings in industries where they have informational advantages. In this paper, we study the relation between the industry concentration and the perfor-mance of actively managed U.S. mutual funds from 1984 to 1999. Our results indicate that, on average, more concentrated funds perform better after controlling for risk and style differences using various performance measures. This finding suggests that investment ability is more evident among managers who hold portfolios concentrated in a few industries. ACTIVELY MANAGED MUTUAL FUNDS are an important constituent of the financial sector. Despite the well-documented evidence that, on average, actively man-aged funds underperform passive benchmarks, mutual fund managers might still differ substantially in their investment abilities.1 In this paper, we exam-ine whether some fund managers create value by concentrating their portfolios in industries where they have informational advantages.