Flow‐driven risk shifting of high‐performing funds

Abstract

Using a sample of open-end equity mutual funds in China from 2004 to 2017, this study investigates the motivations and consequences of flow-driven fund risk shifting behaviour. We find that funds experiencing large inflows tend to reduce their degree of risk-taking. However, good past performance drives funds with high net flows to increase their risk level. High-performing funds increase risk by increasing turnover, increasing the proportion of equity holdings, and buying more winner stocks. Moreover, risk shifting caused by the flow-driven trades of high-performing funds worsens fund performance in the ensuing two quarters before recovering in the third quarter. Finally, high abnormal flow, high performance sourced from luck, young fund age, and small fund size enhance the risk shifting of high-performing funds when experiencing high flow.

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“…Highperforming funds take on more risk by increasing the number of trades, increasing the share of stock holdings, and buying more winners. Flow-driven transactions of high-performing investments also cause risk shifting, which hurts fund performance (Jin et al 2022).…”