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Fund flow bias in market timing skill. Evidence of the clientele effect
Abstract
This paper investigates whether profit-seeking and values-driven investor decisions have an impact on the timing ability of socially responsible mutual fund managers. Surprisingly, we find evidence of successful market timing skill for positively screened mutual fund managers who fulfil the objectives of profit-seeking investors, demonstrating the importance of controlling for the clientele effect. This result may indicate a successful, forward-looking management style in this type of fund. Furthermore, we present certain evidence of the “smart money” phenomenon among profit-seeking investors who pursue the persistent component of returns and thus cause a downward bias in market timing skill.
... In addition to manager attributes, the attributes of the fund, including its clientele, may matter. Larger fund families with lower portfolio turnover tend to exhibit better timing ability [34], and managers of funds with more profit-seeking investors as clients demonstrate better timing abilities [35]. ...
In many financial markets across the globe, full historical position disclosure is not required of mutual funds, or it is subject to prolonged delays, often due to regulatory restrictions. This makes measuring fund manager performance based upon the stock-picking and market-timing skills from past literatures impossible. This study introduces a new methodology utilizing sector weight analysis to estimate the stock-picking and market timing skills of 198 Chinese equity mutual fund managers. Within-sample predictions confirm that the new measures are robust and reliably identify fund managers who outperform their peers, suggesting that this method may be useful in other institutional settings where the full historical position of funds is unavailable. Fund managers with lower stock picking or market timing skills are more likely to improve their skills in the following period, which suggests that manager skills develop and change over time. Finally, our analysis reveals that fund managers with higher stock picking skills are significantly less likely to be replaced, thereby enjoying greater job security.
... Considering the client's perspective, strong empirical evidence has been found about the relation between past investment performance and investors' contribution-and-distribution decisions (Ippolito 1992, Chevalier and Ellison 1997, Del Guercio and Tkac 2002, Bollen 2007, Goyal, and Wahal 2008, Goriaev, Nijman, and Werkel 2008. Another important strand in the literature empirically analyzes the relation between the client's flows and the subsequent realized returns (e.g., Warther 1995, Gruber 1996, Zheng 1999, Sapp and Tiwari 2004, Frazzini and Lamont 2008, Munoz, Vargas and Vicente 2014, Akbas et al. 2015, Jiang and Yuksel 2017. Some of these studies suggest the existence of the clients' selection ability for skilled fund managers (so called smart money effect), whereas some other researches contradict such an effect by finding that investors direct their money to funds with low future returns (so called "dumb money effect"). ...
We present a model of performance measurement and attribution for delegated investments. We introduce an innovative two-dimensional approach that, on one hand, detects the (manager and client) decision effects, measuring the impact on the overall investment performance of the choices made by manager and client in a given period and, on the other hand, detects the (manager and client) period effects, measuring the impact on the period investment performance generated by the entire set of decisions made by manager and client. To accomplish the task, we employ two techniques of analysis and a three-step procedure: we first use the Finite Change Sensitivity Index (FCSI) for measuring the decision effects (step 1); then, we use the Residual Income (RI) approach for measuring the period effects (step 2); finally, we combine the two attribution dimensions into an Attribution Matrix (AM) (step 3) which contains the attribution values. An attribution value provides the amount of value added generated in a given period by the decisions made by the manager or by the investor in (the same or) another period. We apply the AM to an Italian fund, “Anima Italia A”, between 2013 and 2020.
... Andreu et al. (2018) attributed the market timing ability of mutual funds' managers to the fund's size. Muñoz et al. (2014) documented the role of the clientele effect towards funds' performance and suggested that funds' management is influenced by profit-seeking and value-driven investors. Andreu et al. (2019) focused on risk-seeking of mutual funds and highlighted that managers' demographics contribute towards risk profile and consequently impact the financial performance. ...
The paper investigates the impact of human capital efficiency (HCE) on equity funds’ performance during three stages of the COVID-19 pandemic. We collected data for 799 open-ended equity funds across five EU countries and ranked them in five categories of HCE and compare their risk-adjusted performance across these categories. The results suggest that during the COVID-19 outbreak, the equity funds that were ranked higher in HCE outperformed their counterparts. We suggest that fund managers should invest in human capital to improve funds’ coping ability and resilience during periods of extreme stress.
... Andreu et al. (2018) suggested that the performance of mutual funds is largely dependent on the market timing ability, that itself is a function of the size of the funds available. Muñoz et al. (2014) focused on the clientele effect, and attributed it as a possible performance driver. The findings suggested that funds' management is ultimately affected by profit-seeking investors. ...
One of the important contributions of the fourth industrial revolution is the introduction of robo advisors as alternates to conventional mutual funds. Robo advisors are mechanized platforms that use automated algorithms to provide financial advice to investors. This study compares the risk adjusted performance of these automated advisors to the conventional funds that were based in the US between the years 2016 and 2019. Our results show that on average, robo advisors demonstrate superior performance as compared to equity, fixed income, money market and hybrid funds. They also out performed three prominent equity indices, and the results remained robust for different specifications of the risk to reward models. The findings demonstrated that robo advisors not only provide easy access and cost effective advice, but also dominate in the risk adjusted performance.
... The literature on the smart money effect [34][35][36][37] mainly discusses the selection capabilities of mutual fund investors as a whole. The smart money theory holds that institutional investors make judgments and decisions based on sufficient information about the market or the stocks they have. ...
In the current situation of U.S.-China trade turbulence, this study focuses on quarterly panel data from May 2016 to September 2019 in order to verify the effectiveness of feedback trading strategy and smart money theory in stabilizing U.S.-China securities markets and to understand the role of institutional investors’ behavior, to come up with suggestions for improving and perfecting the market mechanism in stabilizing the U.S.-China securities markets. In this study, we adopt the generalized method of moments (GMM) to perform dynamic panel data analysis and discuss the changes in professional institutional investors’ behavior and equity market sentiment in the U.S. and China during the trade turbulence, and then analyze whether that behavior will suppress local stock market sentiment. Through empirical research, we found that institutional investors on both sides of the trade turbulence have a different impact on the stability of the local securities market. The behavior of institutional investors in the United States has played a role in stabilizing equity market sentiment in accordance with feedback trading strategy and smart money theory. However, the behavior of institutional investors in China is the opposite.
... Renneboog et al. (2008a) found ESG investors could not identify funds that subsequently outperform but they could identify funds that were going to underperform. Renneboog et al. (2011) subsequently found no evidence of the effect, but then Munoz et al. (2014) did find evidence of the smart money effect amongst profit-seeking ESG investors. Comparing different time horizons across different fund types (e.g., profit-seeking, religious, screening categories, etc.) could reconcile and explain these divergent results. ...
ESG investing is a large and influential industry. Its activities could be illuminated, appraised and improved by academic research. Unfortunately, research to-date has focused on measuring return performance. A wider range of topics is necessary before research can properly inform investors, companies and regulators. This paper contributes to the challenge by systematically exploring the literature to reveal a richer array of topics: the heterogeneous nature of ESG investing, its costs and motivations, and its management literature origins. In addition to these established topics, five emerging themes are identified: the human element, climate change, fund flows, fixed income and the rise of non-western players.
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... Additionally, some studies also provide evidence that cash inflows previous to an upward market may reduce portfolio betas and therefore, may bias market timing measurement (e.g. Edelen, 1999;and;Muñoz, Vargas, & Vicente, 2014). Another criticism for timing return-based measures is the spurious negative correlation between selection and timing abilities when these measures are applied, as noted by Jagannathan and Korajczyk (1986), Grinblatt and Titman (1989b) and Bollen and Busse (2001), among others. ...
We propose a novel performance attribution model for equity fund portfolios. The model analyses investment decisions based on portfolio holdings and measures the value added from different sources of performance such as past return strategies, security selection, market timing and passive timing. The model was tested for a sample of mutual funds. Empirical results show that security selection is the main contributor to fund performance regardless of the sample period considered or the asset pricing model used. The evidence of timing ability is mixed with low significance. Nevertheless there are noticeable differences between the timing ability of the best and worst performing funds, especially in crisis periods. Analysing the relationship between mutual fund performance (and its different components) and fund characteristics, we find that top funds are significantly smaller and more concentrated than other funds. Finally, we also examine the persistence in the performance and in its components finding evidence of positive persistence in past return strategies and picking skills although this persistence is not shown in the overall performance.
The purpose of this research is to discover the individual investor characteristics that influence their non-economic investing objectives in India. Using an integrated research approach that relies on exploratory factor analysis, the study identifies the factors from the standpoint of individual investors. From the standpoint of fund managers, these aspects were evaluated further. And for this purpose, an expert-based system is analysed to determine the most influential feature or characteristic of individual investors on their choice of non-economic goals. DEMATEL, a tool for multi-criteria decision modelling, is used to analyse the views of experts. The study’s conclusions are applicable to the development of responsible investing solutions for individual investors by asset management companies. The findings will bring about consciousness, interest, and knowledge about the importance of responsible investing behaviour among investors and fund managers who come from a variety of investment backgrounds.KeywordsSocially responsible investmentEFANon-economic GoalsDEMATELIndian investor behaviourJEL Codes G1G40
This paper examines how online lending investor sentiment (OLIS) and investors’ heterogeneous requirements on online lending platforms’ compliance interact to affect online lending rates. Online lending platforms can be divided into different groups according to their compliance clientele, such as state-capital-platforms, listed-company-platforms, banking-platforms, venture-capital-platforms and private-platforms. Using data of platform characteristics and online lending rates in China, we find that online lending investor sentiments and online lending rates vary across the five groups of online lending platforms. Thus, there will be misleading if we use the investor sentiment constructed based on the whole online lending market to study the comovement between investor sentiment and online lending rates of each classification of platforms. We further find the evidence on the clientele effect in online lending market. Particularly, investor sentiment has less impact on online lending rates among platforms invested by investors with stronger requirement on the platforms’ compliance.
This paper examines the financial performance of ethical funds in different regions and concludes that there is a cost attached to ethical investing. An analysis of 964 mutual funds comprising of Socially responsible funds (SRFs) and the Shariah-compliant equity funds (SCFs) suggests that: a) except for global funds, both types of funds underperform in the market, b) both types of funds are preferred for investment in growth and momentum stocks, c) SRFs are preferred for small capitalized stocks whereas SCFs do not follow any specific style or investment strategy, d) unlike SRFs, SCFs do not provide a safe haven for investors during crises. These findings are probably due to the lack of diversification opportunities and poor managerial skills. The results are robust to various asset pricing models and macroeconomic factors.
In this paper, I study investors' selection skills for a broad (576 funds) and updated (January 2004 to May 2018) sample of socially responsible (SR) mutual funds in the US market. In general terms, I obtain a positive relationship between fund flows and subsequent financial performance. This positive relationship is conducted by the bad financial performance of funds suffering net outflows, and it is stronger for non-institutional funds and for funds with a low minimum investment. In addition, I find in general terms that fund flows in US SR funds are persistent, and they are positively related to lagged returns. All these results together seem to indicate that this positive relationship is not driven by investors’ selection skills. Moreover, I observe that religious fund investors are minimally influenced by lagged returns and show the worst selection skills in the US SR fund market. Furthermore, environmental fund investors present the strongest positive relationship between flows and subsequent financial performance, and the flows for these funds are not persistent. When analysing other SR fund markets, I observe in general terms a lack of relationship between fund flows and subsequent financial performance.
This paper studies, for the first time, the cash flow timing skills of socially responsible (SR) mutual fund investors. Our findings show that SR investors neither worsen nor improve their returns according to their cash flow timing decisions, although they show good timing for net purchase and perverse timing for net withdrawal decisions. When controlling for fund characteristics, investors in larger, institutional, with longer mean manager tenure, lower expense ratio, no load, lower mean turnover ratio and a fee level below the average funds, show better timing results; in other words, sophisticated and better informed investors make better cash flow timing decisions. Controlling for SR strategy, green fund investors (our proxy for profit-seeking investors) had the worst results (similar to those obtained for conventional investors in the prior literature), and religious fund investors (our proxy for the values-driven profile) had results that were most different from conventional investors.
We examine investors’ mutual fund selection ability in China. Using actively managed equity mutual funds between 2005 and 2011, we find that Chinese investors generally have no mutual fund selection ability, a result contrary to the smart money effect in the United States. We show that mutual funds that receive more new money subsequently underperform significantly. The findings are robust to several risk-adjusted performance measures. The unique data of China provide separate accounts of institutional and individual investors’ new money flowing into and out of mutual funds, allowing us to examine the mutual fund selection ability of institutional and individual investors. We document that institutional investors exhibit a smart money effect, that is, they are able to move new money into (out of) future good (poor) performers. In contrast, individual investors exhibit a dumb money effect. Our results provide useful information for regulators to review their rules, especially for the protection of individual investors regarding mutual fund investing in China. In addition, we show that it is useful to distinguish institutional and individual investors in mutual fund research.
This study tries to investigate the performance of specific stylized mutual funds focusing on the matched professional abilities of fund managers, based upon their relative educational backgrounds. Using a 2001-2011 dataset on 1,164 fund managers investing in the Taiwan Stock Exchange comprising mainly of high-tech stocks, our findings suggest that mutual fund managers with joint science and engineering (SE) and business management (BM) backgrounds perform significantly better than fund managers only with business management (BM) background when managing high-tech funds. These results also provide support for the notion that the proliferation of joint degree programs across the associated fields lends credence to the belief that synergies exist between the backgrounds in the stylized mutual funds with professional’s education background of fund manager matching with stock targets.
Open-end equity funds provide a diversified equity positions with little direct cost to investors for liquidity. This study documents a statistically significant indirect cost in the form of a negative relation between a fund's abnormal return and investor flows. Controlling for this indirect cost of liquidity changes the average fund's abnormal return (net of expenses) from a statistically significant −1.6% per year to a statistically insignificant −0.2% and also fully explains the negative market-timing performance found in this and other studies of mutual fund returns. Thus, the common finding of negative return performance at open-end mutual funds is attributable to the costs of liquidity-motivated trading.
This paper examines the performance of thirty Hong Kong mutual funds during the period from August 1995 to July 2005. The issues of risk-adjusted performance, selectivity, timing ability and performance persistence are addressed. We employ the signal-factor model, three-factor models and the measurements of Jensen’s alpha and Treynor ratio to evaluate the weekly returns on the sample funds relative to the performance of the Hong Kong market benchmark. Treynor and Mazuy (1966)’s quadratic model is used for assessing selectivity and timing ability of fund managers. Performance persistence of Hong Kong mutual funds is assessed at successive two-year intervals based on their ranking according to both Jensen measure and Treynor measure. Evidence of underperformance of Hong Kong mutual funds relative to the market is found. No significant selectivity and timing ability are shown in the results of the actively managed mutual funds. Persistence is identified for the performance of both winners and losers in the short run.
I study the dynamics of investor cash flows in socially responsible mutual funds. Consistent with anecdotal evidence of loyalty, the monthly volatility of investor cash flows is lower in socially responsible funds than in conventional funds. I find strong evidence that cash flows into socially responsible funds are more sensitive to lagged positive returns than cash flows into conventional funds, and weaker evidence that cash outflows from socially responsible funds are less sensitive to lagged negative returns. These results indicate that investors derive utility from the socially responsible attribute, especially when returns are positive.
This paper studies the performance of 60 European funds from four countries. The paper extends the UK matched pair approach for fund evaluation developed by Mallin et al. (1995) to a European setting. The findings suggest that there is no difference between ethical and non-ethical funds according to the performance measures employed. Neither type of fund displayed any ability to time the market. Finally, the results indicate that the management fee is a significant explanatory variable for the Jensen measure as Chen et al. (1992) and Grinblatt and Titman (1994) suggested. Copyright Blackwell Publishers Ltd, 2005.
There exists a widespread consensus among mainstream academics and investors that socially responsible investing (SRI) leads to inferior, rather than superior, portfolio performance. Using Innovest’s well-established corporate ecoefficiency scores, we provide evidence to the contrary. We compose two equity portfolios that differ in eco-efficiency characteristics and find that our highranked portfolio provided substantially higher average returns compared to its low-ranked counterpart over the period 1995-2003. Using a wide range of performance attribution techniques to address common methodological concerns, we show that this performance differential cannot be explained by differences in market sensitivity, investment style, or industry-specific components. We finally investigate whether this eco-efficiency premium puzzle withstands the inclusion of transaction costs scenarios, and evaluate how excess returns can be earned in a practical setting via a best-in-class stock selection strategy. The results remain significant under all levels of transactions costs, thus suggesting that the incremental benefits of SRI can be substantial.
The segmentation of the socially responsible investing (SRI) movement with a values-versus-profit orientation solves the puzzling evidence that both socially responsible and controversial stocks produce superior returns. We derive that the segment of values-driven investors primarily uses “negative” screens to avoid controversial stocks, while the profit-driven segment uses “positive” screens. As the result of an empirical analysis over the period 1992–2008, we base our segmentation on investment screens that help us to examine whether values affect prices. We find that, although the profit-driven segment earns abnormal returns in the short run, these profit-generating opportunities do not persist in the long run for SRI stocks. However, our conclusions highlight the observation that different views on SRI can be complementary in the short run.
The market timing ability of fund managers remains a major research issue in finance. In the Australian context greater personal responsibility is now required for retirement incomes via superannuation fund investments of individuals. Accordingly the performance of these funds is an issue of major public policy importance. This paper extends the previous literature by exploring the market timing ability of Australian superannuation funds using the class of non-linear smooth transition models. The paper develops a tiered definition of market timing ability in terms of strong form, mild form and weak form. The analysis shows that the conventional models used to measure market timing ability of Treynor and Mazuy (1966) and Henriksson and Merton (1981) and Merton (1981) are appropriate for measuring market timing ability. Consistent with the previous literature we find only limited evidence in support of strong market timing ability.
We evaluate the directional accuracy of the Institute for Supply Management indices to predict the US economy direction with a method developed by Pesaran and Timmermann (2009). By illustrating an application of the new market-timing test, we show that the Non-Manufacturing Index is a useful predictor of an increase/decrease and acceleration/deceleration in monthly economic activity, whereas the renowned Purchasing Managers’ Index is not. Our findings suggest that the non-manufacturing sector is important when examining US business cycles.
Previous studies show that interest rates, dividend yields, and other commonly available variables are useful market indicators, but until now, measures of fund performance have not used the information. This article modifies classical performance measures to take account of well-known market indicators. The conditional performance evaluation approach avoids some of the biases that plague traditional measures. Applied to a sample of mutual funds, the conditional measures make the funds' performance look better.
The evaluation of investment fund performance has been one of the main developments of modern portfolio theory. Most studies employ the technique developed by Jensen (1968) that compares a particular fund's returns to a benchmark portfolio of equal risk. However, the standard measures of fund manager performance are known to suffer from a number of problems in practice. In particular previous studies implicitly assume that the risk level of the portfolio is stationary through the evaluation period. That is unconditional measures of performance do not account for the fact that risk and expected returns may vary with the state of the economy. Therefore many of the problems encountered in previous performance studies reflect the inability of traditional measures to handle the dynamic behaviour of returns. As a consequence Ferson and Schadt (1996) suggest an approach to performance evaluation called conditional performance evaluation which is designed to address this problem. This paper utilises such a conditional measure of performance on a sample of 27 UK property funds, over the period 1987-1998. The results of which suggest that once the time varying nature of the funds beta is corrected for, by the addition of the market indicators, the average fund performance show an improvement over that of the traditional methods of analysis.
We use a panel of 155 countries to assess the links between growth, productivity and government debt. Via growth equations we assess simultaneity, endogeneity, cross-section dependence, nonlinearities, and threshold effects. We find a negative effect of the debt ratio. For the OECD, the higher the debt maturity the higher economic growth; financial crisis are detrimental for growth; fiscal consolidation promotes growth; and higher debt ratios are beneficial to TFP growth. The growth impact of a 10% increase in the debt ratio is -0.2% (0.1%) respectively for countries with debt ratios above (below) 90% (30%), and an endogenous debt ratio threshold of 59% can be derived.
Typical socially responsible investors tilt their portfolios toward stocks of companies with high scores on social responsibility characteristics such as community, employee relations and the environment. We analyze returns during 1992-2007 of stocks rated on social responsibility by KLD and find that this tilt gave socially responsible investors a return advantage relative to conventional investors. However, typical socially responsible investors also shun stocks of companies associated with tobacco, alcohol, gambling, firearms, military, and nuclear operations. We find that such shunning brought to socially responsible investors a return disadvantage relative to conventional investors. The return advantage of tilts toward stocks of companies with high social responsibility scores is largely offset by the return disadvantage that comes from the exclusion of stocks of 'shunned' companies. The return of the DS 400 Index of socially responsible companies was approximately equal to the return of the S&P 500 Index of conventional companies. Socially responsible investors can do both well and good by adopting the best-in-class method in the construction of their portfolios. That method calls for tilts toward stocks of companies with high scores on social responsibility characteristics, but refrains from calls to shun the stock of any company, even one that produces tobacco.
This paper investigates the market timing abilities of private equity fund managers using a unique set of detailed cash-flow data. We show that investment timing has an impact on the performance of venture capital funds. Surprisingly, divestment timing has no such impact on returns. For later-staged buyout funds our analysis reveals that fund performance is not driven by market timing but is significantly related to the experience of the individual fund manager. Thus, for successful investing into more mature portfolio companies, getting access to better deal flow and managing the investment affect the resulting success of these investments. Our results complement other recent findings on the performance of private equity funds.
This paper investigates the relation between international mutual fund flow and local/home market returns following Warther (1995) and Froot, O'Connell and Seasholes (2001). Like the U.S. domestic results, the concurrent local market return is found to be very important to explain the international mutual fund flow rather than the home market return. The concurrent relation between the local return and the international mutual fund flow could be explained by information hypothesis rather than price pressure effect in the context of international mutual funds. Furthermore, the lagged local market returns do not have any significant effect on the flow, implying that no positive-feedback trading exists. Interestingly, the coefficients of lagged exchange rates for Japan-related funds are negative and statistically significant. That could be called positive-feedback trading from the viewpoint of exchange rate. Last, the U.S. market factor is not statistically significant for explaining the international mutual fund flow, but for the local return after controlling for the effects of expected and unexpected fund flows.
We examined the performance of 115 global equity-based hedge funds with reference to their target geographical markets in the seven-year period 1994-2000. Several results are noteworthy. First, global hedge fund managers do not show positive market-timing ability but do demonstrate superior security-selection ability; the Jensen's alphas we found, before and after controlling for market timing, are sizable and positive. Second, incentive fees and leverage both have a significant positive impact on a hedge fund's risk-adjusted return (as demonstrated by Sharpe ratios and Jensen's alphas) but not on a fund's "selectivity index" (i.e., its performance after controlling for market-timing effects). Third, incentive fees can lower the hedge fund's up-market and down-market systematic risk. Fourth, the size of a hedge fund is consistently related to its return performance. Finally, contrary to the general perception, leverage does not significantly affect the systematic risk of hedge funds.
This study investigates whether the relation between macro-level fund flow and market returns varies between the retail and institutional fund management markets. We find evidence of a contemporaneous relation between flow and market return for retail funds and also find evidence to support the notion that retail investors are feedback traders. In contrast, we find no relation between flow and market return for institutional funds, consistent with these investors being more informed than their retail counterparts. We find no evidence of flow inducing price pressure for either group of funds.
We study the relation between market returns and unexpected aggregate flow into U.S. equity funds, using semi-weekly and daily flow data. The reaction of flow and return --whether it be one reacting to the other, or both reacting to a third factor -- is fast and strong. The flow-return relation is mainly concurrent, but flow also follows returns with a one-day lag. The lagged response of flow indicates either a common response of both returns and flow to new information, or positive feedback trading. Additional tests suggest that the concurrent relation reflects flow driving returns.
We examine the market timing performance of a sample of high quality corporate bond funds over the 1994-2003 time period. After establishing that the funds do engage in market timing activity, we find strong evidence of perverse market timing ability between cash and bonds and additional evidence of negative timing skill across bond maturities. A significant portion of the perverse timing ability that we detect across the fund sample is driven by the subset of funds with the highest expense ratios. Robustness tests suggest that our results reflect actual and not spurious timing ability. Overall, our results indicate that bond fund managers do not share the positive market timing ability of other groups of money managers that has been recently documented in the literature.
In this paper we use data on the monthly holdings for a set of mutual funds to study the timing ability of these funds. By examining monthly holdings we are able to see how management changes the risk parameters and industry holdings in a fund and to examine how this contributes to timing. We find evidence that timing decisions result in a decrease in performance, whether timing is measured using conditional or unconditional sensitivities. Likewise, sector rotation decisions also result in lower returns. Examining the results for individual sectors shows that the majority of the negative impact on returns from sector rotation comes about because of a fund changing exposure to high-tech stocks.
More and more investors apply socially responsible screens when building their stock portfolios. This raises the question whether these investors can increase their performance by incorporating such screens into their investment process. To answer this question we implement a simple trading strategy based on socially responsible ratings from the KLD Research & Analytics: Buy stocks with high socially responsible ratings and sell stocks with low socially responsible ratings. We find that this strategy leads to high abnormal returns of up to 8.7% per year. The maximum abnormal returns are reached when investors employ the best-in-class screening approach, use a combination of several socially responsible screens at the same time, and restrict themselves to stocks with extreme socially responsible ratings. The abnormal returns remain significant even after taking into account reasonable transaction costs.
Existing studies of mutual fund market timing analyze monthly returns and find little evidence of timing ability. We show that daily tests are more powerful and that mutual funds exhibit significant timing ability more often in daily tests than in monthly tests. We construct a set of synthetic fund returns in order to control for spurious results. The daily timing coefficients of the majority of funds are significantly different from their synthetic counterparts. These results suggest that mutual funds may possess more timing ability than previously documented.
The study analyzes the relation between a trading imbalance metric that captures data observable by investors, and future momentum and reversals in Taiwan index futures returns. Standard regression analyses do not show any significant dynamic relations between daily index futures returns and the trading imbalance, regardless of whether the trading imbalance metric is lagged, contemporaneous, or leads the index futures return. However, when the analyses are focused on periods with extreme trading imbalances I find that the daily index futures returns exhibit significant reversals following periods of extreme (low) trading imbalances and low returns. I also find some evidence of residual momentum in consecutive daily index futures returns following periods of extreme (high) trading imbalances and high returns. Trading simulation, directional accuracy, and market timing tests show these effects to be economically significant, even after accounting for transaction costs.
We study the money flows into and out of socially responsible investment (SRI) funds around the world. In their investment decisions, investors in SRI funds may be more concerned with ethical or social issues than with fund performance. Therefore, SRI money flows are less related to past fund returns. Ethical money is less sensitive to past negative returns than are conventional fund flows, especially when SRI funds primarily use negative or Sin/Ethical screens. Social attributes of SRI funds weaken the relation between money inflows and past positive returns. However, money flows into funds with environmental screens are more sensitive to past positive returns than are conventional fund flows. Stock picking based on in-house SRI research increases the money flows. These results give evidence on the role of nonfinancial attributes, which induce heterogeneity of investor clienteles within SRI funds. We find no evidence of a smart money effect, as the funds that receive more inflows neither outperform nor underperform their benchmarks or conventional funds.
The aim of this study is the analysis of the performance of so-called socially responsible investments (SRI). The performance of SRI equity investment funds of Germany, Switzerland and the United States as well as equity indices is investigated using Jensen's alpha as performance measure. The analysis of the fund performance considers market timing strategies of the fund management and takes publicly available information into account (conditional performance). It is found that most of the SRI assets (funds and indices) have a similar performance compared to their benchmarks. Only a few funds and indices exhibit a relatively poor performance. Thus, an investor in SRI assets can expect a similar risk-adjusted return compared to an investment in conventional assets, although SRI is only a subset of the total investment universe.
In this paper I find that aggregate security returns are highly correlated with concurrent unexpected cash flows into mutual funds, but unrelated to concurrent expected flows. An unexpected inflow equal to 1% of total stock fund assets ($4.75 billion) corresponds to a 5.7% increase in the stock price index. Further, fund flows are correlated with the returns of the securities held by the funds, but not with the returns of other types of securities. I find evidence of a positive relation between flows and subsequent returns and evidence of a negative relation between returns and subsequent flows.
This study examines the pricing efficiency of E-mini and floor-traded index futures under electronic versus open-outcry trading platforms. By using OLS and quantile regressions to control for changes in market characteristics, we find that pricing errors are smaller in the E-mini markets than the floor-traded markets, thereby confirming that electronic trading has special attractions for arbitrageurs and informed traders. However, during periods of higher volatility, the advantages of speedier execution, anonymity and information efficiency may be offset by arbitrage risks; as a result, larger pricing errors are observed in the E-mini markets. We provide new evidence confirming the important roles in pricing efficiency played by both traditional open-outcry systems and electronic trading systems.
This paper assesses the importance of fund flows in the performance evaluation of Australian international equity funds. Two concepts of fund flows are considered in the context of a conditional asset pricing model. The first measure is net fund flow relative to fund size and the second is net fund flow relative to sector flows. We find that incorporating a fund flow measure relative to the sector flow results in a reduction of measured perverse market timing. The results indicate that, at the individual fund level, cash flows are relevant in assessing management outcomes.
This paper investigates and compares the determinants of fund flows for socially responsible investment (SRI) funds and conventional funds. We consider the impact of current and past measures of monthly and annual return on fund flow. The results suggest SRI fund flows are less sensitive to returns than conventional funds. Our model also shows that flow is persistent and SRI investors are more likely to invest in a fund they already own relative to conventional investors. These results reflect the difficulty SRI investors face in finding alternative investments that meet their non-financial goals.
This paper explores daily international portfolio flows into and out of 44 countries from 1994 through 1998. We find several facts concerning the behavior of flows and their relationship with equity returns. First, we detect regional flow factors that have increased in importance through time. Second, the flows appear to be stationary, but far more persistent than returns. Third, flows are strongly influenced by past returns, a finding consistent with positive feedback trading by international investors. Fourth, inflows have positive forecasting power for future equity returns, and this power is statistically significant in emerging markets. Fifth, the sensitivity of local stock prices to foreign inflows is positive and large. Sixth, prices seem consistent with flow persistence, in that transitory inflows impact future returns negatively.
I examine how CEO compensation is related to firms’ capital structures. My tests address the simultaneity of these decisions and distinguish between debt types with different theoretical implications for managerial incentives. Pay–performance sensitivity decreases in straight-debt leverage, but is higher in firms with convertible debt. Furthermore, stock option policy is the component of CEO pay that is most sensitive to differences in capital structure. The results strongly support the hypothesis that firms trade-off shareholder-manager incentive alignment in order to mitigate shareholder-bondholder conflicts of interest. The hypothesis that debt reduces manager-shareholder conflicts can explain some but not all of the results.
This study simultaneously analyzes the relation between aggregate stock market returns and cash flows (net purchases of equity) from a broad array of investor groups in the United States over a long period of time from 1952 to 2004. We find strong evidence that quarterly flows are autocorrelated for each of the different investor groups. We further document a significant and positive contemporaneous relation between stock market returns and flows of Mutual Funds and Foreign Investors.
In this paper, we propose a nonparametric test for market timing ability and apply the analysis to a large sample of mutual funds that have different benchmark indices. The test statistic is formed to proxy the probability that a manager loads on more market risk when the market return is relatively high. The test (i) only requires the ex post returns of funds and their benchmark portfolios; (ii) separates the quality of timing information a money manager possesses from the aggressiveness with which she reacts to such information; and (iii) is robust to different information and incentive structures, as well as to underlying distributions. Overall, we do not find superior timing ability among actively managed domestic equity funds for the period of 1980–1999. Further, it is difficult to predict funds' timing performance from their observable characteristics.
We study the relation between market returns and aggregate flow into U.S. equity funds, using daily flow data. The concurrent daily relation is positive. Our tests show that this concurrent relation reflects flow and institutional trading affecting returns. This daily relation is similar in magnitude to the price impact reported for an individual institution's trades in a stock. Aggregate flow also follows market returns with a one-day lag. The lagged response of flow suggests either a common response of both returns and flow to new information, or positive feedback trading.
We use mutual fund flows as a measure of individual investor sentiment for different stocks, and find that high sentiment predicts low future returns. Fund flows are dumb money–by reallocating across different mutual funds, retail investors reduce their wealth in the long run. This dumb money effect is related to the value effect: high sentiment stocks tend to be growth stocks. High sentiment also is associated with high corporate issuance, interpretable as companies increasing the supply of shares in response to investor demand.
This paper provides a critical review of the literature on socially responsible investments (SRI). Particular to SRI is that both financial goals and social objectives are pursued. Over the past decade, SRI has experienced an explosive growth around the world reflecting the increasing awareness of investors to social, environmental, ethical and corporate governance issues. We argue that there are significant opportunities for future research on the increasingly important area of SRI. A number of questions are reviewed in this paper on the causes and the shareholder-value impact of corporate social responsibility (CSR), the risk exposure and performance of SRI funds and firms, as well as fund subscription and redemption behavior of SRI investors. We conclude that the existing studies hint but do not unequivocally demonstrate that SRI investors are willing to accept suboptimal financial performance to pursue social or ethical objectives. Furthermore, the emergence of SRI raises interesting questions for research on corporate finance, asset pricing, and financial intermediation.
This paper examines a potential agency conflict between mutual fund investors and mutual fund companies. Investors would like the fund company to use its judgment to maximize risk-adjusted fund returns, the fund company has an incentive to increase the inflow of investments. The authors estimate the shape of the flow-performance relationship for a sample of growth and growth and income funds observed over the 1982-92 period. The shape creates incentives for fund managers to alter the riskiness of their portfolios. Examining portfolio holdings, the authors find that risk levels are changed toward the end of the year in a manner consistent with these incentives. Copyright 1997 by the University of Chicago.
Funds under management by Danish mutual funds have increased by 25% annually during the last 10 years and measured per capita Denmark has the third largest mutual fund industry in Europe. This paper provides the first independent performance analysis of Danish mutual funds. We analyse selectivity applying a single index model and a multi-factor model, respectively. Furthermore, we analyse the timing ability of the Danish mutual funds pursuing both the quadratic regressions of Treynor and Mazuy (1966) and the option approach suggested by Henriksson and Merton (1981). Finally, we analyse performance persistence using parametric as well as non-parametric methodologies. We conclude that in general Danish mutual funds perform neutrally, returns are non-persistent and Danish mutual funds have no timing ability.
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. Copyright The American Finance Association 1998.
The relative performance of no-load, growth-oriented mutual funds persists in the near term, with the strongest evidence for a one-year evaluation horizon. Portfolios of recent poor performers do significantly worse than standard benchmarks; those of recent top performers do better, though not significantly so. The difference in risk-adjusted performance between the top and bottom octile portfoli os is six to eight percent per year. These results are not attributable to known anomalies or survivorship bias. Investigations with a differen t (previously used) data set and with some post-1988 data confirm the finding of persistence. Copyright 1993 by American Finance Association.
In this paper the method of least absolute deviations is applied to the estimation of the parameters of a structural equation in the simultaneous equations model. A class of estimators called two stage least absolute deviations estimators is defined, their asymptotic properties are derived, and the problem of finding the optimal member of the class is considered.
Mutual funds represent one of the fastest growing type of financial intermediary in the American economy. The question remains as to why mutual funds and in particular actively managed mutual funds have grown so fast, when their performance on average has been inferior to that of index funds. One possible explanation of why investors buy actively managed open end funds lies in the fact that they are bought and sold at net asset value, and thus management ability may not be priced. If management ability exists and it is not included in the price of open end funds, then performance should be predictable. If performance is predictable and at least some investors are aware of this, then cash flows into and out of funds should be predictable by the very same metrics that predict performance. Finally, if predictors exist and at least some investors act on these predictors in investing in mutual funds, the return on new cash flows should be better than the average return for all investors in these funds. This article presents empirical evidence on all of these issues and shows that investors in actively managed mutual funds may have been more rational than we have assumed.
The use of predetermined variables to represent public information and time-variation has produced new insights about asset pricing models but the literature on mutual fund performance has not exploited these insights. This paper advocates conditional performance evaluation in which the relevant expectations are conditioned on public information variables. The authors modify several classical performance measures to this end and find that the predetermined variables are both statistically and economically significant. Conditioning on public information controls for biases in traditional market timing models and makes the average performance of the mutual funds in the authors' sample look better. Copyright 1996 by American Finance Association.
The price of ethics and stakeholder governance: the performance of socially responsible mutual funds
- Renneboog
Investor behavior in the mutual fund industry: evidence from gross flows
- Cashman