Investor Behavior & Disclosure
Out of Sight No More? The Effect of Fee Disclosures on Investment Allocations
Mathias Kronlund (University of Illinois), Veronika Pool (Indiana University) and Clemens Sialm (UT Austin), Irina Stefanescu (Board of Governors)
Using a hand-collected dataset on investment menus for a large sample of 401(k) plans, we examine the effects of a 2012 regulatory reform of investment option disclosures on participants' allocations across funds. We show that participants become significantly more attentive to expense ratios and short-term performance after the reform. The results are stronger for plans with larger account balances and those that are non-unionized. Additionally, they are not driven by secular changes in investor attention or sponsor-initiated changes to the investment menu before the reform.
Do Retail Investors Respond to Firm-Initiated Summary Disclosures? Evidence from Mutual Fund Factsheets
Alper Darendeli (Nanyang Technological University)
Regulators and standard setters are increasingly exploring alternative ways of simplifying communication with investors. This study examines the relationship between summary disclosures and retail investor decisions. Using novel, hand-collected data on mutual fund factsheets, which convey short-form summaries of fund performance and risk, I explore voluntary disclosure of mutual funds and its relation with fund flows. I find evidence that flows are more sensitive to performance and risk metrics when disseminated, and therefore made salient, through factsheets than when they are not. Consistent with individual investors with limited attention driving the results, the effect is stronger for flows pertaining to retail share classes. Finally, disclosure-induced trading leaves retail investors worse off as funds disseminating their performance measures in factsheets tend to underperform funds that do not. Overall, this study provides some of the first large-sample evidence on the consequences and information dissemination role of firm-initiated summary documents.
Peer Versus Pure Benchmarks in the Compensation of Mutual Fund Managers
Richard Evans (Darden), Juan-Pedro Gómez (IE Business School), Linlin Ma (Peking University), and Yuehua Tang (University of Florida)
We examine the role of peer (e.g. Lipper Manager Benchmark) vs. pure (S&P 500) benchmarks in mutual fund manager compensation. We find that while the majority of portfolio managers are compensated based on some combination of peer and pure benchmarks, 29% (21%) of portfolio managers report compensation based only a peer (pure) benchmark. Funds with peer-benchmark compensated managers charge higher fees, but still outperform on a risk-adjusted net performance basis. Pure-benchmark compensated managers, on the other hand, exhibit lower active share and return gap, as well as higher R2, consistent with less effort and/or ability. In assessing the advisor level determinants of the peer/pure benchmark decision, we find that advisors that choose peer-benchmarking are relatively larger, focused on a lower number of client types, more likely to be direct distributed and located in cities with less asset managers. Overall, these results are consistent with market segmentation playing a role in the difference between peer and pure benchmarked investment advisors.
Managerial Structure and Performance-Induced Trading
Anastassia Fedyk (UC Berkeley), Saurin Patel (Western University) and Sergei Sarkissian (McGill University)
We propose a new channel through which teamwork improves mutual fund activity: by offsetting individual overconfidence, teams mitigate excessive performance-induced trading. The predictions of our theoretical model are confirmed in the data. Team-managed funds trade less after good performance than single-managed funds, and the magnitude of this differential increases with team size. Moreover, changes from single- to team-management correspond to lower performance-induced trading. Our results cannot be explained by alternative explanations, including manager experience, gender, and fund flows. Heavy trading by single-managed funds results in lower next-period returns compared to team-managed funds. Our findings indicate that team-management reduces overconfident trading.
Coping with Market Stress
Liquidity Support in Financial Institutions
Falko Fecht (Frankfurt School of Finance & Management), Egemen Genc (Rotterdam School of Management), Yigitcan Karabulut (Frankfurt School of Finance & Management)
Using a unique administrative dataset of portfolio holdings of all financial institutions in Germany, we analyze the fund flows from banks to their affiliated mutual funds. We document that parent banks provide support to their affiliated mutual funds against temporary liquidity shortfalls that is beneficial both for the funds and existing fund investors. We further demonstrate that banks provide this liquidity support by directing their retail and institutional customers to their distressed funds, who, in exchange, enjoy a liquidity premium over the subsequent period. Thus, our results indicate that banks can internalize the externalities arising from temporary liquidity shocks both for their affiliated-funds and their customers.
Alternative Pricing Rules to Prevent Runs on Funds
Jin Dunhong (U of Oxford), Marcin Kacperczyk (Imperial College), Bige Kahraman (U of Oxford), and Felix Suntheim (Financial Conduct Authority)
We analyze the impact of open-end funds’ alternative pricing mechanisms on their run risks.
Alternative pricing (known as swing or dual pricing) adjusts funds’ net asset values to pass on
more of funds’ trading costs to shareholders associated with that activity. Using a sample of
European corporate bond mutual funds subjected to such rules, we show that these funds are
less likely to experience runs during periods of market stress. Fund companies perceive their
pricing schemes as a substitute to other potential means of liquidity risk management.
Institutional Brokerage Networks: Facilitating Liquidity Provision
Munhee Han (UT Dallas), Sanghyun Kim (UT Dallas), Vikram Nanda (UT Dallas)
We argue that institutional brokerage networks facilitate liquidity provision and mitigate trading costs associated with adverse selection. Using brokerage commission payments, we map trading networks of mutual funds and their brokers. We find that central funds in the network tend to outperform peripheral funds, especially in terms of return gap. The outperformance is more pronounced when funds’ trading activities are primarily motivated by liquidity reasons, such as to accommodate large fund outflows. The fund–centrality premium is further driven up by brokers’ incentives to generate greater commission revenues and by trading relationships that funds have established with their brokers. Exploiting large brokerage mergers as exogenous shocks to the network structure, we show that plausibly exogenous changes in brokerage network centrality are accompanied by predicted changes in return gap.
Cross-Asset Information Synergy in Mutual Fund Families
Jun Kyung Auh (Georgetown University), Jennie Bai (Georgetown University)
Despite common wisdom that equities and bonds are segmented, the organization structure of fund families can offset frictions regarding asset market segmentation. We find that equity funds and corporate bond funds linked within a mutual fund family (sister funds) exhibit a significant co-movement in holdings of commonly-held firms’ equities and bonds. In contrast, we do not find such a pattern for funds in different families. We show that the holding co-movement is driven by information sharing among sister funds, and such funds make more profit-enhancing investment decisions on common holdings, compared to stand-alone funds. Our findings suggest that collaboration between equity funds and bond funds improves fund performance.
Unobserved Performance of Hedge Funds
Vikas Agarwal (Georgia State University), Stefan Ruenzi (University of Mannheim), and Florian Weigert (University of St. Gallen)
We investigate hedge funds’ unobserved performance (UP), measured as the risk-adjusted return difference between a fund firm’s reported return and the hypothetical portfolio return derived from its disclosed long equity holdings. We find that high UP is (i) positively associated with measures of managerial incentives, discretion, and skill, and (ii) driven by a fund firm’s frequent trading in equity positions, derivatives usage, short selling, and confidential holdings. Fund firms with high UP outperform fund firms with low UP by more than 6% p.a. after accounting for typical hedge fund risk factors and fund characteristics.