Copycat Funds: Information Disclosure Regulation and the Returns to Active Management in the Mutual Fund Industry

Abstract

Mutual funds must disclose their portfolio holdings to investors semiannually. The costs and benefits of such disclosures are a long-standing subject of debate. For actively managed funds, one cost of disclosure is a potential reduction in the private benefits from research on asset values. Disclosure provides public access to information on the assets that the fund manager views as undervalued. This paper tries to quantify this potential cost of disclosure by testing whether "copycat" mutual funds, funds that purchase the same assets as actively-managed funds as soon as those asset holdings are disclosed, can earn returns that are similar to those of the actively-managed funds. Copycat funds do not incur the research expenses associated with the actively-managed funds that they are mimicking, but they miss the opportunity to invest in assets that managers identify as positive return opportunities between disclosure dates. Our results for a limited sample of high expense funds in the 1990s suggest that while returns before expenses are significantly higher for the underlying actively managed funds relative to the copycat funds, after expenses copycat funds earn statistically indistinguishable, and possibly higher, returns than the underlying actively managed funds. These findings contribute to the policy debate on the optimal level and frequency of fund disclosure.

Is There a Cost to Transparency?

“…Alternatively, other investors could mimic, with a lag, the positions of the best-performing funds. Notably, Frank, Poterba, Shackelford, and Shoven (2004) demonstrated that copycat portfolios that mimic the disclosed positions of mutual funds generate static returns that are similar to the returns of the actual funds. Wermers, Yao, and Zhao (2007) also found substantial excess returns, even beyond the 60-day reporting requirement lag.…”

The effect of holdings data frequency on conclusions about mutual fund behavior

“…Mimicking is advantageous if a fund can benefit from another fund's security selection without bearing the cost of doing research. Frank et al (2004) show that copycat funds can earn a substantial portion of the return of the fund being copied. The ability to successfully copycat depends on how quickly the private information of the fund manager is incorporated in price.…”

Does style-shifting activity predict performance? Evidence from equity mutual funds

“…Nevertheless, implementing holdings-based approaches has several disadvantages. 2 First, a timely determination of fund activity can be difficult, because fund managers typically disclose portfolio holdings at the latest possible date, otherwise so-called copycat funds could steal a substantial portion of the copied fund's return (see, e.g., Frank, Poterba, Shackelford, & Shoven, 2004;Phillips, Pukthuanthong, & Rau, 2014). For this reason, current legal regulation allows funds to disclose quarterly portfolio holdings with a considerable lag of 60 days (U.S. Securities and Exchange Commission, 2004).…”