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The shrouded business of style drift in active mutual funds

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  • Chua, Angeline Kim Pei
  • Tam, On Kit

Abstract

This study investigates the motivation and performance consequence of intentional style drift in an exclusively in-house fund management industry in China. With style drift, fund investors are exposed to investment portfolio outside their risk-return preference but are generally unaware that their risk and return expectations are disrupted, and the functioning of the fund market undermined. Our study provides evidence for the first time about the incentive that motivates style drift behavior. We find that style drift increases a fund's subsequent net inflows, thus affirming the maximization of AUM-linked compensation as the motivation for fund manager's style drift behavior. We also find that larger funds have greater incentive to drift. We demonstrate that style drift behavior interferes with the picking of quality stocks to deliver fund performance for fund investors. Style drift as an unobserved risk behavior harms fund investor interest and undermines market integrity.

Suggested Citation

  • Chua, Angeline Kim Pei & Tam, On Kit, 2020. "The shrouded business of style drift in active mutual funds," Journal of Corporate Finance, Elsevier, vol. 64(C).
    • Handle: RePEc:eee:corfin:v:64:y:2020:i:c:s0929119920301115
    DOI: 10.1016/j.jcorpfin.2020.101667
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    Cited by:

    1. Zehua He & Kexin Hu & Zhongfei Li, 2023. "Drifting from the Sustainable Development Goal: Style Drift in ESG Funds," Sustainability, MDPI, vol. 15(16), pages 1-24, August.
    2. Zhang, Ning & Zhang, Yue & Zong, Zhe, 2023. "Fund ESG performance and downside risk: Evidence from China," International Review of Financial Analysis, Elsevier, vol. 86(C).
    3. Cathy S Goldberg & Carol M Graham & Francisco A Delgado, 2022. "Style Drift and Alphas: A Case Study in International Retail Funds," Accounting and Finance Research, Sciedu Press, vol. 11(1), pages 1-24, February.
    4. Giuseppe Galloppo, 2021. "Size," Springer Books, in: Asset Allocation Strategies for Mutual Funds, chapter 0, pages 151-190, Springer.
    5. Wang, Xiaoxiao, 2023. "Bank affiliation and mutual funds’ trading strategy distinctiveness," International Review of Financial Analysis, Elsevier, vol. 88(C).
    6. Perez Katarzyna & Szczyt Małgorzata, 2021. "Classification of Open-End Investment Funds Using Artificial Neural Networks. The Case of Polish Equity Funds," Central European Economic Journal, Sciendo, vol. 8(55), pages 269-284, January.

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    More about this item

    Keywords

    Style drift; Mutual funds; Holdings-based analysis; Stock picking; Compensation design; Risk-taking incentive;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • N25 - Economic History - - Financial Markets and Institutions - - - Asia including Middle East

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