Mutual fund trading around mergers and fund performance

Abstract

Purpose The purpose of this paper is to investigate whether mutual funds (MFs) take positions in companies that subsequently engage in M&As and whether fund managers adjust portfolio holdings in the same direction as wealth creation from mergers. Further, the study is the first to examine the relation between active trading surrounding M&As and risk-adjusted performance in MFs. Design/methodology/approach The sample includes mergers conducted by publicly traded acquirers of public and private targets over 2003–2016. Several measures of MF managerial activeness in M&As are introduced: merger trading intensity (proportional change in fund’s holdings of M&A stocks), active merger weight (deviation of the fund’s actual weights in M&A stocks and value weights) and active merger trading (deviation of the fund’s actual weights in M&A stocks from the average weights in M&A stocks across the funds within the same Center for Research in Security Prices objective). Findings Fund managers who are more vested in the firms engaged in M&As and who are more active in their trades of M&A firms generate higher contemporaneous and subsequent risk-adjusted performance, indicative of managerial skill. Active M&A trading effect on performance is economically meaningful. Originality/value This is the first study to examine whether previously documented predictive power of active institutions regarding M&As’ profitability leads to higher risk-adjusted returns for MF investors. The study introduces several measures to gauge how actively fund managers trade companies engaged in M&As and contributes to the literature on MF managers’ ability to pick stocks.

Pre-announcement merger trading by investment bank-affiliated mutual funds

“…The coefficient on the indicator for negative target CAR is not significant in any model specifications. This result is broadly consistent with Kaprielyan et al (2019), who find no robust relation between the combined CAR of merging firms and general institutional trading in the quarter preceding a merger announcement. Coefficients on control variables are generally in line with univariate results.…”

“…Results contrast with work of Griffin et al (2012), who do not find robust evidence of information spillover within banks. Results also add to the literature on M&A outcomes and the likelihood of merger success or withdrawal, particularly in the context of institutional trading and merger outcomes, including the work of Kaprielyan et al (2019) and Ashraf and Jayaraman (2014). Finally, our results complement anecdotal reports in the popular press of conflicts of interest within financial conglomerates.…”

“…We also employ an indicator variable that equals 1 if a merger target has negative announcement period abnormal returns. Control variables are included, which have been shown in previous literature to be associated with institutional trading leading up to merger announcements- Kaprielyan et al (2019) and Ashraf and Jayaraman (2014) employ various target, deal, and acquirer characteristics. Models (1) and ( 2) include target firm characteristics, (3) and ( 4) include acquirer and deal characteristics, and ( 5) and ( 6) include both target and acquirer/deal characteristics.…”

“…Chen et al (2007) show that some institutions reduce portfolio holdings in the year, leading up to mergers with poor announcement returns; however, the authors do not find evidence of shorter-term trading closer to the merger announcement date. Kaprielyan et al (2019) analyze changes in mutual fund holdings leading up to merger announcements, and they find a positive relation between the likelihood of a merger announcement and a fund increasing its holdings of both acquirer and target stock in the quarter preceding the announcement. Agarwal et al (2013) examine hedge fund holdings that are disclosed on a delayed basis due to confidential treatment from the U.S. Securities and Exchange Commission (SEC), and they find that such confidential holdings have higher abnormal returns and are more likely to be associated with merger announcements, consistent with the argument that hedge fund managers have an informational advantage in their confidential holdings.…”

The Underperformance of Acquiring Mutual Funds: A Re-Examination of a Puzzle

“…Nain and Yao (2013) show that the success of mergers is partly driven by stock selection ability of fund manager. Kaprielyan et al (2020) argue that mutual fund managers who perform active trading on merger announcement achieve a better risk-adjusted fund returns, resulting from their stock picking ability. We argue that management structure of mutual funds may affect the target selection process and therefore the post-acquisition performance and size of acquiring funds, especially for within-family mergers.…”