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Broker Incentives and Mutual Fund Market Segmentation

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  • Diane Del Guercio
  • Jonathan Reuter
  • Paula A. Tkac

Abstract

We study the impact of investor heterogeneity on mutual fund market segmentation. To motivate our empirical analysis, we make two assumptions. First, some investors inherently value broker services. Second, because brokers are only compensated when they sell mutual funds, they have little incentive to recommend funds available at lower cost elsewhere. The need for mutual fund families to internalize broker incentives leads us to predict that the market for mutual funds will be highly segmented, with families targeting either do-it-yourself investors or investors who value broker services, but not both. Using novel distribution channel data, we find strong empirical support for this prediction; only 3.3% of families serve both market segments. We also predict and find strong evidence that mutual funds targeting performance-sensitive, do-it-yourself investors will invest more in portfolio management. Our findings have important implications for the expected relation between mutual fund fees and returns, tests of fund manager ability, and the puzzle of active management. Furthermore, they suggest that changing the way investors compensate brokers will change the nature of competition in the mutual fund industry.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16312.

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Date of creation: Aug 2010
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Handle: RePEc:nbr:nberwo:16312

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  1. Massa, Massimo & Reuter, Jonathan & Zitzewitz, Eric, 2010. "When should firms share credit with employees? Evidence from anonymously managed mutual funds," Journal of Financial Economics, Elsevier, Elsevier, vol. 95(3), pages 400-424, March.
  2. Marcin Kacperczyk & Clemens Sialm & Lu Zheng, 2005. "Unobserved Actions of Mutual Funds," NBER Working Papers 11766, National Bureau of Economic Research, Inc.
  3. Javier Gil-Bazo & Pablo Ruiz-Verdu, 2005. "When Cheaper Is Better: Fee Determination In The Market For Equity Mutual Funds," Business Economics Working Papers, Universidad Carlos III, Departamento de Economía de la Empresa wb054309, Universidad Carlos III, Departamento de Economía de la Empresa.
  4. Ľuboš Pástor & Robert F. Stambaugh, 2012. "On the Size of the Active Management Industry," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 120(4), pages 740 - 781.
  5. Judith Chevalier & Glenn Ellison, 1999. "Are Some Mutual Fund Managers Better Than Others? Cross-Sectional Patterns in Behavior and Performance," Journal of Finance, American Finance Association, American Finance Association, vol. 54(3), pages 875-899, 06.
  6. Guercio, Diane Del & Tkac, Paula A., 2002. "The Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds vs. Pension Funds," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 37(04), pages 523-557, December.
  7. Sendhil Mullainathan & Markus Noeth & Antoinette Schoar, 2012. "The Market for Financial Advice: An Audit Study," NBER Working Papers 17929, National Bureau of Economic Research, Inc.
  8. Javier Gil-Bazo & Pablo Ruiz-Verd�, 2009. "The Relation between Price and Performance in the Mutual Fund Industry," Journal of Finance, American Finance Association, American Finance Association, vol. 64(5), pages 2153-2183, October.
  9. Khorana, Ajay & Servaes, Henri, 1999. "The Determinants of Mutual Fund Starts," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 12(5), pages 1043-74.
  10. Jonathan Reuter & Eric Zitzewitz, 2005. "Do Ads Influence Editors? Advertising and Bias in the Financial Media," Finance, EconWPA 0501003, EconWPA.
  11. Daniel Bergstresser & John M. R. Chalmers & Peter Tufano, 2009. "Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 22(10), pages 4129-4156, October.
  12. Lauren Cohen & Andrea Frazzini & Christopher Malloy, 2007. "The Small World of Investing: Board Connections and Mutual Fund Returns," NBER Working Papers 13121, National Bureau of Economic Research, Inc.
  13. Amit Goyal & Sunil Wahal, 2008. "The Selection and Termination of Investment Management Firms by Plan Sponsors," Journal of Finance, American Finance Association, American Finance Association, vol. 63(4), pages 1805-1847, 08.
  14. Camelia M. Kuhnen, 2009. "Business Networks, Corporate Governance, and Contracting in the Mutual Fund Industry," Journal of Finance, American Finance Association, American Finance Association, vol. 64(5), pages 2185-2220, October.
  15. Glode, Vincent, 2011. "Why mutual funds "underperform"," Journal of Financial Economics, Elsevier, Elsevier, vol. 99(3), pages 546-559, March.
  16. Ali Hortacsu & Chad Syverson, 2003. "Product Differentiation, Search Costs, and Competition in the Mutual Fund Industry: A Case Study of the S&P 500 Index Funds," NBER Working Papers 9728, National Bureau of Economic Research, Inc.
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Cited by:
  1. Cici, Gjergji & Kempf, Alexander & Sorhage, Christoph, 2013. "Are financial advisors useful? Evidence from tax-motivated mutual fund flows," CFR Working Papers, University of Cologne, Centre for Financial Research (CFR) 12-09 [rev.2], University of Cologne, Centre for Financial Research (CFR).
  2. Cici, Gjergji & Kempf, Alexander & Sorhage, Christoph, 2013. "Are financial advisors useful? Evidence from tax-motivated mutual fund flows," CFR Working Papers, University of Cologne, Centre for Financial Research (CFR) 12-09 [rev.], University of Cologne, Centre for Financial Research (CFR).
  3. Sendhil Mullainathan & Markus Noeth & Antoinette Schoar, 2012. "The Market for Financial Advice: An Audit Study," NBER Working Papers 17929, National Bureau of Economic Research, Inc.
  4. Nicola Gennaioli & Andrei Shleifer & Robert Vishny, . "Money Doctors," Working Paper 69721, Harvard University OpenScholar.
  5. Cici, Gjergji & Kempf, Alexander & Sorhage, Christoph, 2012. "Are financial advisors useful? Evidence from tax-motivated mutual fund flows," CFR Working Papers, University of Cologne, Centre for Financial Research (CFR) 12-09, University of Cologne, Centre for Financial Research (CFR).
  6. Santosh Anagol & Shawn Cole & Shayak Sarkar, 2012. "Understanding the Advice of Commissions-Motivated Agents: Evidence from the Indian Life Insurance Market," Harvard Business School Working Papers, Harvard Business School 12-055, Harvard Business School, revised Jan 2013.
  7. Diane Del Guercio & Jonathan Reuter, 2011. "Mutual Fund Performance and the Incentive to Generate Alpha," NBER Working Papers 17491, National Bureau of Economic Research, Inc.
  8. John Chalmers & Jonathan Reuter, 2012. "What is the Impact of Financial Advisors on Retirement Portfolio Choices and Outcomes?," NBER Working Papers 18158, National Bureau of Economic Research, Inc.

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