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Smart fund managers? Stupid money?

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  • Dan Bernhardt
  • Ryan J. Davies

Abstract

We develop a model of mutual fund manager investment decisions near the end of quarters. We show that when investors reward better performing funds with higher cash flows, near quarter‐ends a mutual fund manager has an incentive to distort new investment toward stocks in which his fund holds a large existing position. The short‐term price impact of these trades increase the fund's reported returns. Higher returns are rewarded by greater subsequent fund inflows which, in turn, allow for more investment distortion the next quarter. Because the price impact of trades is short term, each subsequent quarter begins with a larger return deficit. Eventually, the deficit cannot be overcome. Thus, our model leads to the empirically observed short‐run persistence and long‐run reversal in fund performance. In doing so, our model provides a consistent explanation of many other seemingly contradictory empirical features of mutual fund performance. Les auteurs développent un modèle de décisions d'investissement des gestionnaires de fonds mutuels près de la fin d'un trimestre. On montre que quand les investisseurs récompensent les fonds mutuels performants en y injectant des ressources additionnelles, vers la fin d'un trimestre, le gestionnaire de fonds a une incitation à infléchir le nouvel investissement vers des actions dans lesquelles le fond a une forte position existante. L'impact de ces transactions sur les prix de ces actions à court terme augmente les rendements trimestriels rapportés pour le fond. De meilleurs rendements sont récompensés par un influx d'investissement subséquent, ce qui ouvre la porte à encore plus de déflection d'investissement au trimestre suivant. Parce que l'impact de ces transactions sur le prix des actions est à court terme, chaque trimestre subséquent commence avec un déficit de rendements plus important. Eventuellement, il n'est plus possible de combler ce déficit. Ce modèle permet d'expliquer les observations empiriques de persistance de mesures de performance du fond à court terme et de renversement de la tendance à long terme. Le modèle fournit aussi une explication consistante de plusieurs autres caractéristiques apparemment contradictoires notées empiriquement dans la performance des fonds mutuels.

Suggested Citation

  • Dan Bernhardt & Ryan J. Davies, 2009. "Smart fund managers? Stupid money?," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 42(2), pages 719-748, May.
    • Handle: RePEc:wly:canjec:v:42:y:2009:i:2:p:719-748
    DOI: 10.1111/j.1540-5982.2009.01525.x
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    Cited by:

    1. Jonathan B. Berk & Richard C. Green, 2004. "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1269-1295, December.
    2. Li, Xiangwen & Wu, Wenfeng, 2019. "Portfolio pumping and fund performance ranking: A performance-based compensation contract perspective," Journal of Banking & Finance, Elsevier, vol. 105(C), pages 94-106.
    3. Duong, Truong X. & Meschke, Felix, 2020. "The rise and fall of portfolio pumping among U.S. mutual funds," Journal of Corporate Finance, Elsevier, vol. 60(C).
    4. Tsung-Yu Hsieh, 2015. "Information disclosure and price manipulation during the pre-closing session: evidence from an order-driven market," Applied Economics, Taylor & Francis Journals, vol. 47(43), pages 4670-4684, September.
    5. Tālis J. Putniņš, 2012. "Market Manipulation: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 26(5), pages 952-967, December.
    6. Kadıoğlu, Eyüp & Frömmel, Michael, 2022. "Manipulation in the bond market and the role of investment funds: Evidence from an emerging market," International Review of Financial Analysis, Elsevier, vol. 79(C).
    7. Comerton-Forde, Carole & Putnins, Talis J., 2011. "Measuring closing price manipulation," Journal of Financial Intermediation, Elsevier, vol. 20(2), pages 135-158, April.
    8. Chang, Rosita P. & Rhee, S. Ghon & Stone, Gregory R. & Tang, Ning, 2008. "How does the call market method affect price efficiency? Evidence from the Singapore Stock Market," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2205-2219, October.
    9. Bernhardt, Dan & Davies, Ryan J., 2005. "Painting the tape: Aggregate evidence," Economics Letters, Elsevier, vol. 89(3), pages 306-311, December.
    10. Ying-Fen Fu, 2014. "Individual Fund Manager Sentiment, Fund Performance and Performance Persistence," International Journal of Economics and Financial Issues, Econjournals, vol. 4(4), pages 870-885.
    11. Jie Gao & Yang Feng & Zeshui Xu & Qianlin Luo, 2023. "Analysis of strategic deviance decisions considering investors’ risk aversion and the industrial earnings forecast errors," International Entrepreneurship and Management Journal, Springer, vol. 19(1), pages 379-402, March.
    12. Carole Comerton-Forde & Tālis J. Putniņš, 2014. "Stock Price Manipulation: Prevalence and Determinants," Review of Finance, European Finance Association, vol. 18(1), pages 23-66.

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G2 - Financial Economics - - Financial Institutions and Services
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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