A Mispricing-Based Explanation of How Flow Affects Mutual Fund Performance

Abstract

Using fund raw return as a proxy for unsophisticated flows, I find that future fund performance increases in alpha and decreases in flow. I show that funds holding stocks which, in aggregate, have been sold by funds with low flows do better in the future. Such stocks have had their prices pushed down, and therefore outperform. A measure of these “aggregate flow-induced sales” of a fund’s portfolio largely subsumes raw return in predicting future fund performance. These results have implications for the debate on whether flows are responsible for the lack of mutual fund performance persistence.