Mutual Funds and Risk Disclosure: Information Content of Fund Prospectuses

Mutual funds are mandated by the Securities and Exchange Commission (SEC) to disclose information on their investment objectives and risks. In this paper, we study the informational value of U.S. mutual funds’ qualitative disclosures by analyzing the content of funds’ prospectuses. First, we find that funds disclosed risks increase with their exposed risk. They inform, in particular, extensively about their idiosyncratic risks and less about their systematic risks. Second, using methods from textual analysis, we document that around one-third of the variation in the content of funds’ risk disclosures is fund-specific, while a substantial part of a fund’s risk disclosures is determined at the fund group level. Our findings suggest that the relative informativeness in funds’ prospectuses has been, on average, decreasing over time. Third, we show that regular content-based updates of the disclosed risks provide relevant information in predicting future fund performance. Investors, however, do not react to this new information but rather to the content’s informativeness. Finally, using an event study framework relying on matching techniques, we document that investors also do not respond to the provision of additional simplified disclosure.