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This paper examines the influence of past performance on Israeli equity mutual funds' net flows between January 2004 and July 2014, using the most recommended and reliable two-cluster regression methodology. Apparently, Israeli investors are more sensitive to risk adjusted returns than absolute returns and the most recent performance seems to be more influential on fund flows than on longer-term past performance. Moreover, investors flock to the latest winners and do not leave the funds with the poorest performance. The effect of past performance seems to be more salient on flows of advertised funds than of those with no advertisement. The results in Israel augment the scant work on mutual fund flows outside the US and add support to a growing body of literature documenting irrational investor behavior worldwide.

Most of the studies on asset allocation put policy at the forefront of their studies, claiming that it is the most important factor contributing to returns. They usually ignore the fact that even in the absence of a long-term perspective; funds can still achieve returns by simply putting money in the capital markets. In this paper, we used 15 years of monthly data for the Israeli provident funds to assess the relative importance of capital market movements and asset allocation policy separately against the timing and selection abilities of fund managers. We found that, according to time-series analysis, total market movements, which account for more than 70% of total returns, predominantly influence returns and the incremental contribution of policy above the market is only 17%. Moreover, policy explains less than half of the variations in excess market returns. Indeed, policy is no better than active management in explaining variations in returns both across time and between funds. Remarkably, security selection dictates both the return level and the variation in returns from active management (53% in cross sectional analysis), while the influence of timing is found negligible (below 10% on average).

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