Another Puzzle: The Growth in Actively Managed Mutual Funds

Abstract

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.

Fund performance-flow relationship and the role of institutional reform

“…Existing research based on earlier dataset before the enforcement of the revised LPRCSIF reports that Chinese mutual funds lack performance persistence and investors tend to make less optimal decisions in fund investment. Therefore, the smart money effect which is revealed in the US market is not observed in China (Feng et al, 2014;Gruber, 1996;Jun et al, 2014;Zheng, 1999). This can be ascribed to the unfamiliarity of investors with the funds that they are going to trade.…”

Causality Illusion and Overconfidence in Predicting (Quasi)Stochastic Financial Events

“…Aplikovaným odrazem tohoto chování na finančních trzích je důvěra ve schopnost aktivně řízených fondů systematicky překonávat výnosnost příslušného tržního indexu. Ačkoliv existuje notorická série důkazů o globálně horším výkonu aktivně spravovaných fondů než pasivních indexovaných nástrojů [Fama a French, 2010;French, 2008;Gruber, 1996], svěřují drobní i velcí investoři v obrovském rozsahu své finanční zdroje do aktivně řízených fondů. Debata o univerzálnosti těchto zjištění nicméně není u konce [viz např.…”

Active Management and Price Efficiency of Exchange-traded Funds

“…Various explanations are thus developed in the literature to justify this contradiction from the rational expectation perspective. Gruber (1996) attributes this phenomenon to the fact that funds are bought and sold at net asset value without pricing management ability. In this sense, performance and cash fl ows into and out of funds are predictable so that sophisticated investors can earn above-average returns in these funds.…”