Why Does Mutual Fund Performance Not Persist? The Impact and Interaction of Fund Flows and Manager Changes

Bessler, Wolfgang; Blake, David; Lückoff, Peter; Tonks, Ian

doi:10.2139/ssrn.1695890

“…Consistently with this explanation, Bessler et al (2010) show that outflows from underperforming funds alone cannot eliminate their performance disadvantage. 1 Reuter and Zitzewitz (2010) study the effect of fund flows on performance using a regression discontinuity approach and estimate diseconomies of scale of a magnitude larger than estimated in standard regression but insufficient to eliminate performance persistence.…”

Section: Bg's Influential Work Has Changed the Prevalent View On Mutusupporting

confidence: 60%

“…This line of research includes the studies of Ferreira et al (2010), Elton et al (2001), Berk and Tonks (2007), and Glode et al (2011), in addition to the work of Bessler et al (2010), cited above. Ferreira et al (2010) study differences in performance persistence across countries and find that such differences are associated with differences in the degree of diseconomies of scale and fund competition.…”

Section: Bg's Influential Work Has Changed the Prevalent View On Mutumentioning

confidence: 99%

Market Frictions, Investor Sophistication and Persistence In Mutual Fund Performance

Dumitrescu¹,

Gil-Bazo

²

2012

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If there are diseconomies of scale in asset management, any predictability in mutual fund performance will be arbitraged away by rational investors seeking funds with the highest expected performance (Berk and Green, 2004). In contrast, the performance of US equity mutual funds persists through time. In this paper, we report evidence that persistence is less prevalent among hard-to-find funds and investigate whether market frictions can reconcile the assumptions of investor rationality and diseconomies of scale with the empirical evidence. In particular, we extend the setting of Berk and Green (2004) to include entry costs and account for investor heterogeneity in financial sophistication, which we model as differences in reservation returns and the degree of financial constrainedness across investors. We show that for low levels of managerial skill, more visible funds, which are available to a broad set of investors, underperform less visible funds, which are only available to the most sophisticated investors. As managerial skill rises, funds with less sophisticated investors can outperform funds with more sophisticated investors, as a consequence of the interaction of entry costs with financial constraints. Therefore, for a range of managerial skill, hard-to-find funds exhibit less dispersion in equilibrium expected performance. Using data on US equity mutual funds in the 1996-2010 period and different proxies for fund visibility, we find empirical evidence that differences in observed performance are significantly less persistent among hard-to-find funds than otherwise similar funds.JEL codes: G2; G23.

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“…Consistently with this explanation, Bessler et al (2010) show that outflows from underperforming funds alone cannot eliminate their performance disadvantage.…”

Section: Bg's Influential Work Has Changed the Prevalent View On Mutusupporting

confidence: 60%

Market frictions, investor sophistication, and persistence in mutual fund performance

Dumitrescu

¹

,

Gil-Bazo

²

2018

Journal of Financial Markets

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If there are diseconomies of scale in asset management, any predictability in mutual fund performance will be arbitraged away by rational investors seeking funds with the highest expected performance (Berk and Green, 2004). In contrast, the performance of US equity mutual funds persists through time. In this paper, we report evidence that persistence is less prevalent among hard-to-find funds and investigate whether market frictions can reconcile the assumptions of investor rationality and diseconomies of scale with the empirical evidence. In particular, we extend the setting of Berk and Green (2004) to include entry costs and account for investor heterogeneity in financial sophistication, which we model as differences in reservation returns and the degree of financial constrainedness across investors. We show that for low levels of managerial skill, more visible funds, which are available to a broad set of investors, underperform less visible funds, which are only available to the most sophisticated investors. As managerial skill rises, funds with less sophisticated investors can outperform funds with more sophisticated investors, as a consequence of the interaction of entry costs with financial constraints. Therefore, for a range of managerial skill, hard-to-find funds exhibit less dispersion in equilibrium expected performance. Using data on US equity mutual funds in the 1996-2010 period and different proxies for fund visibility, we find empirical evidence that differences in observed performance are significantly less persistent among hard-to-find funds than otherwise similar funds.JEL codes: G2; G23.

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“…The authors conclude the persistence phenomenon is a useful indicator for mutual funds investors, but the evidence of earning excess returns remains weak. Bessler et al (2010) investigate the factors impacting non-persistent performance of mutual funds by examining 3946 US equity mutual funds from 1992 to 2007.The authors find mutual funds that outperform the market could continuously perform well only if there are no high inflows or changes in the management structure,while mutual funds that underperform the market could significantly improve their performance where outflows occur and the manager is replaced. Malkiel (1995) uses Jensen (1968) alpha as the measurement for equity funds performance.The author ranked the mutual funds every year from 1971 to 1991 using the funds' quarterly returns.…”

Section: Persistence Of Mutual Funds Performancementioning

confidence: 99%