Mutual Fund Performance and Performance Persistence: The Impact of Fund Flows and Manager Changes (Geld - Banken - Börsen)

Superior investment performance is the ultimate objective of mutual fund investors. However, past fund performance is no reliable indicator of future performance. Peter LÃ1⁄4ckoff investigates why fund flows and manager changes act as equilibrium mechanisms and drive the performance of both previously outperforming and previously under-performing funds back to average levels. These results have important implications for investors, investment management companies and regulators. 414ZAnuGelL......Page 1 978-3-8349-2780-4......Page 2 Foreword......Page 6 Preface......Page 8 Contents......Page 10 List of Tables......Page 17 List of Figures......Page 20 Motivation and Relevance......Page 22 Objective and Structure......Page 26 1 Institutional Setting......Page 32 1.1 Role of Mutual Funds......Page 34 Professional Management......Page 43 Diversification......Page 45 Additional Services......Page 46 1.3.1 Return Predictability and Equilibrium Considerations......Page 47 1.3.2 Active versus Passive Investing......Page 54 1.3.3.1 Indexing and Enhanced Indexing......Page 60 1.3.3.2 Fundamental Indexing......Page 65 1.3.3.3 Active Long-Only Strategies......Page 66 1.3.3.4 Active Long-Short Strategies......Page 68 1.3.3.5 Activist Investors......Page 69 1.4 Organizational Design......Page 71 1.4.1 Open-End Funds......Page 74 1.4.2 Exchange-Traded Funds......Page 83 1.4.3 Retail Structured Products......Page 85 1.4.4 Closed-End Funds......Page 88 1.4.5 Hedge Funds......Page 89 1.4.6 Comparison of Different Structures......Page 91 1.5 Discussion......Page 95 2 Agency Conflicts......Page 97 2.1 Potential Conflicts of Interest......Page 98 2.1.1 Investors and Portfolio Managers 2.1.1.1 Career Concerns and Tournaments Tournament Behavior......Page 100 Strategic Interaction and Family Tournaments......Page 103 Further Empirical Evidence and Statistical Issues......Page 104 2.1.1.2 Herding......Page 105 2.1.2.1 Distribution Channels and Advertisement Brokers and Financial Advisors......Page 107 Advertising Performance......Page 109 Changing Names and Pretending Innovation......Page 110 2.1.2.2 Fund Families and “Star” Managers Strategically Boosting Fund Performance......Page 111 Strategically Starting, Merging and Closing Funds......Page 113 2.1.2.3 Benchmark Gaming and Performance Manipulation Benchmark Gaming......Page 116 Portfolio Pumping......Page 118 Window Dressing......Page 119 2.1.3 Costs and Potential Third-Party Benefits......Page 120 2.1.3.1 Costs......Page 121 2.1.3.2 Directed Brokerage and Soft Dollars......Page 122 2.1.3.3 Market Timing and Late Trading Market Timing......Page 124 Late Trading......Page 125 2.1.4 Discussion......Page 126 2.2 Potential Solutions for Reducing Agency Conflicts......Page 127 2.2.1 Investment Strategy and Instruments......Page 129 2.2.2 External Governance 2.2.2.1 Transparency and Competition......Page 131 2.2.2.2 Market-Based Control......Page 133 2.2.3 Internal Governance......Page 137 2.2.3.1 Fund Board......Page 138 2.2.3.2 Manager Changes......Page 140 2.2.3.3 Optimal Fund Size......Page 143 2.2.4.1 Performance-Based Compensation......Page 144 2.2.4.2 Ownership Structures......Page 148 2.2.5 Discussion......Page 152 3 Performance Measurement......Page 154 3.1 Choice of the Correct Performance Measure......Page 155 3.1.1 Asset Class and Investment Strategy......Page 157 3.1.2 Existing Portfolio......Page 158 3.1.4 Institutional Setting......Page 159 3.2 Ratio-Based Performance Evaluation......Page 160 3.2.1 Information Ratio and Sharpe Ratio......Page 161 3.2.3 Ratios for Non-Normally Distributed Returns......Page 162 3.3 Risk-Based Performance Evaluation......Page 165 3.3.1 Jensen Model......Page 167 3.3.1.1 Benchmark Problem......Page 169 3.3.1.2 Time Variability......Page 171 3.3.1.3 Statistical Problems......Page 174 3.3.2.1 Fama-French Model: Size and Value Effect......Page 176 3.3.2.2 Carhart Model: Momentum Effect......Page 178 3.3.2.3 Construction of Factor-Mimicking Portfolios......Page 180 3.3.3 Timing Models and Conditional Performance Evaluation......Page 184 3.4 Interpretation of Multifactor Models......Page 187 3.4.1 Risk-Based Explanations 3.4.1.1 Time-Varying Asset Composition......Page 188 3.4.1.2 Macroeconomic Risk, Business Cycle and Default Risk Macroeconomic Risk and the Business Cycle......Page 191 Default Risk......Page 192 3.4.1.4 Liquidity Risk......Page 193 3.4.1.5 Higher Moments and Downside Risk Higher Moments......Page 197 Downside Risk......Page 198 3.4.1.6 Idiosyncratic Risk......Page 199 3.4.2 Behavioral Explanations......Page 201 Underreaction......Page 202 Overconfidence......Page 203 Transaction Costs......Page 204 Trading Volume......Page 206 3.4.4 Methodological Issues......Page 207 Migration......Page 208 Delistings......Page 209 3.4.5 Statistical Issues......Page 210 Time Variability......Page 211 3.4.6 Discussion......Page 212 3.5 Portfolio-Information-Based Performance Evaluation......Page 213 3.5.1 Characteristic-Based Models......Page 215 3.5.2 Holdings-Based Models......Page 219 3.5.3 Trade-Based Models......Page 221 3.6.1 Bootstrapping......Page 222 3.6.2 Bayesian Approach......Page 223 3.6.4 Controlling for Cross-Correlation......Page 228 3.7.1 Fund Performance......Page 229 3.7.2 Investor Performance......Page 232 3.7.3 Implications for Active Mutual Fund Management......Page 235 3.8 Cross-Sectional Performance Determinants......Page 240 3.8.1 Managerial Skill and Information-Related Determinants 3.8.1.1 Investment Style Portfolio Turnover......Page 241 Portfolio Concentration......Page 244 3.8.1.2 Information Access Financial Centers and Regional Proximity......Page 246 Information Networks......Page 248 3.8.1.3 Manager Characteristics Education......Page 249 Gender......Page 250 3.8.2 Cost-Related Determinants......Page 251 Fees......Page 252 Transaction Costs......Page 253 Taxes......Page 255 3.8.3 Fund-Related Determinants Fund Size and Fund Family Size......Page 256 Fund Age......Page 258 Regulatory Environment......Page 259 3.9 Discussion......Page 260 4 Dynamic Aspects of Mutual Fund Performance......Page 262 4.1.1 Performance Persistence......Page 264 Stock Return Momentum......Page 265 Competition......Page 266 Other Predictable Patterns......Page 267 4.1.2 Potential Data Biases Survivorship Bias......Page 268 Look-Ahead Bias......Page 269 Ranking Measures......Page 270 Evaluation Measures......Page 273 4.1.4 Potential Model Biases Investment Style......Page 274 Omitted Factors......Page 275 4.1.5 Discussion......Page 276 4.2.1 Characteristics of Fund Flows......Page 277 4.2.2 Performance-Flow Relationship......Page 279 Family Effects......Page 280 Evidence from Other Investment Products......Page 281 4.2.3 Shape of the Performance-Flow Relationship......Page 282 Behavioral Issues......Page 283 4.2.4 Impact of Costs and Brokers on Fund Flows Costs......Page 284 Clientele Effects......Page 286 Broker Advice......Page 289 4.2.5 Speed of Reaction......Page 291 Gross Inflows......Page 292 Gross Outflows......Page 293 Time Period......Page 294 4.2.7 Discussion......Page 295 4.3 Fund Flows as Equilibrium Mechanism......Page 296 Unintentional Beta Variation......Page 301 4.3.2 Transaction Costs and Distorted Security Selection Transaction Costs......Page 302 Distorted Security Selection......Page 304 4.3.3 Ownership Price Pressure......Page 306 Position Liquidity......Page 308 Investment Style......Page 309 Asset Liquidity......Page 310 4.3.5 Portfolio Concentration......Page 311 Best Ideas......Page 312 Hierarchy Costs......Page 313 4.3.6 Discussion......Page 314 4.4 Manager Changes as Equilibrium Mechanisms......Page 316 4.4.1 Winner Funds......Page 317 4.4.2 Loser Funds......Page 318 4.4.3 Empirical Results......Page 319 4.4.4 Interaction with Fund Flows......Page 320 4.5 Approaches to Reduce the Detrimental Impact of Flows on Performance......Page 321 4.5.1 Redemption Restrictions Lock-up Periods, Redemption Notice Periods and Gates......Page 322 4.5.2 Fee Structure Load Fees and Redemption Fees......Page 325 Performance Fees and High-Water Marks......Page 327 4.5.3 Creation Restrictions Soft Closing......Page 328 4.5.4 Trading and Pricing Mechanisms Swing Pricing......Page 329 Secondary Market......Page 330 Exchange-Traded Funds......Page 333 4.5.5 Investment Strategy Derivatives......Page 335 Alternative Benchmark......Page 338 Funds of Funds......Page 339 Closed-End Funds......Page 341 Pension Funds......Page 342 4.6 Discussion......Page 344 5.1 Objectives......Page 346 5.2 Data......Page 351 5.3 Methodology......Page 358 5.3.1 Ranked Portfolio Test 5.3.1.1 Formation......Page 359 5.3.1.2 Evaluation......Page 361 5.3.2 Regression Approach......Page 364 6.1 Research Questions and Hypotheses......Page 366 6.2.1 Characteristics......Page 368 6.2.2 Performance......Page 373 6.2.3 Alternative Ranking Measures......Page 381 6.3.1 Objective......Page 388 6.3.2 Methodology......Page 390 6.3.3 Bayesian Alphas......Page 393 6.3.4 Alternative Estimation Methodologies......Page 404 6.4 Alternative Formation and Evaluation Periods......Page 410 Raw Returns......Page 411 Risk-Adjusted Returns of Decile Portfolios......Page 413 Risk-Adjusted Returns of Individual Decile Funds......Page 416 Discussion......Page 418 6.5 Migration......Page 419 7.1 Research Questions and Hypotheses......Page 428 7.1.1 Winner Funds......Page 429 7.1.2 Loser Funds......Page 433 7.2.1 Portfolio Formation......Page 435 7.2.2 Specification of Multifactor Models......Page 438 7.3.1 Single sorting......Page 441 7.3.2 Double sorting......Page 453 7.4.1 Single Sorting......Page 458 7.4.2 Double Sorting......Page 472 7.5 Winner-Minus-Loser Spread......Page 478 7.6 Before-Fee Analysis......Page 481 7.7.1 Model Specification......Page 487 7.7.2 Results......Page 489 7.8 Discussion......Page 491 8.1 Research Questions and Hypotheses......Page 495 8.2.1 Winner Funds......Page 499 8.2.2 Loser Funds......Page 503 8.3.1 Portfolio Formation......Page 505 8.3.2 Winner Funds......Page 506 8.3.3 Loser Funds......Page 512 8.4.1 Portfolio Formation......Page 516 8.4.2 Winner Funds......Page 517 8.4.3 Loser Funds......Page 522 Summary of the Results......Page 526 Conclusions and Outlook......Page 535 A.1 Factor-Mimicking Portfolios......Page 543 A.2 Sample Selection......Page 545 A.3 Alternative Estimation Methodologies......Page 546 Absolute-Fund-Flows Sorting......Page 547 Absolute-Fund-Flows Sorting......Page 549 Relative-Fund-Flows Sorting......Page 551 A.5.1 Winner Funds Absolute-Fund-Flows Sorting......Page 554 Fund-Size Sorting......Page 556 Factor Loadings......Page 557 A.5.2 Loser Funds Absolute-Fund-Flows Sorting......Page 559 Relative-Fund-Flows Sorting......Page 561 Fund-Size Sorting......Page 562 Factor Loadings......Page 563 A.6 Interaction of Fund Flows and Fund Size......Page 565 Bibliography......Page 567 Superior investment performance is the ultimate objective of mutual fund investors. However, past fund performance is no reliable indicator of future performance. Peter Lückoff investigates why fund flows and manager changes act as equilibrium mechanisms and drive the performance of both previously outperforming and previously underperforming funds back to average levels. These results have important implications for investors, investment management companies and even regulators.