A Flow-Based Explanation for Return Predictability

Abstract

Dong Lou has been teaching at the London School of Economics since July 2009. He earned a Ph.D. in Finance from Yale University and a B.S. in Computer Science from Columbia University. Lou's research mostly focuses on understanding market inefficiencies, and their distortionary effects on resource allocation (such as capital and managerial effort) in the real economy. In his Ph.D. dissertation, Lou shows that mutual fund investment-flow induced trading can have a long-lasting return effect in the stock market. In some follow-up projects, Lou further studies the potential effects of such temporary price pressure on firms' debt financing and investment decisions, and firms' interactions with non-equity stakeholders, such as suppliers and customers. Any opinions expressed here are those of the authors and not necessarily those of the FMG. The research findings reported in this paper are the result of the independent research of the authors and do not necessarily reflect the views of the LSE.

The relation between fees and return predictability in the mutual fund industry

“…In sum, the results from the multivariate regression analysis confirm the findings about mutual fund fees predictability and show that the coefficients of other fund variables are in line with prior studies (see Lou, 2012). Table 7 presents the results of Eq.…”

Financial Crisis and Corporate Social Responsible Mutual Fund Flows

“…Bollen (2007) shows that the monthly volatility of investor cash flows is lower in socially responsible funds than conventional funds and hence, it is plausible that risk-averse fund managers are willing to trade off cash flows in exchange of lower flow volatility (by holding more top CSR stocks). : 2003-2007-2012 In this section, we partition the whole sample into two subsamples 2003-2007 and 2008-2012 and estimate model (1) and (2) using each of the sub-samples. Table 3 reports the results.…”

“…The current literature has established that future flows can be predicted by lagged fund performance and fund flows (Sirri and Tufano 1998;Berk and Green 2004;Lou 2012;Coval and Stafford 2007, etc.). Our paper shows that in addition to fund performance and fund flows, fund investments in CSR stocks can predict future fund flows.…”

Are mutual funds sitting ducks?

“…Brunnermeier and Pedersen (2005) show that predatory trading, trading that induces and/or exploits the need of other investors to reduce their positions, is profitable for the predators, harmful to the victims, and affects prices. Stafford, 2007;Lou, 2010;Ben-Rephael, Kandel, and Wohl, 2011) finds that investor flows into mutual funds, in aggregate or at the fund level, are robustly related to past flows and returns at various horizons. Wermers et al (2010) show that publicly disclosed mutual fund portfolio holdings contain valuable information about future returns.…”

“…Coval and Stafford (2007) and Lou (2010) find that mutual funds tend to expand and contract their portfolios in their existing proportions, which enables one to predict which stocks the funds will trade. Coval and Stafford (2007) also show that front-running anticipated trades by distressed mutual funds is a profitable strategy.…”