Adverse Information and Mutual Fund Runs

Abstract

This paper is the first one to document that anticipation of adverse events can trigger runs in mutual funds. Using the event of the 2003 and 2004 litigations filed in the U.S. over market-timing and late-trading practices, we find that runs start as early as six months before litigation announcements. The pre-event runs are about half the size of runs that follow announcements, which is about 1% of total assets per month. In addition, investors who run before litigation announcements earn significantly higher risk- and peer-adjusted returns than those who run after because, as the return data on fund holdings show, the former avoid fire-sale costs. In funds holding illiquid assets or funds incurring large outflows, the cumulative differences in abnormal returns can be as high as 6%. Hence, our analysis suggests that a pro-rata ownership design is not sufficient to prevent runs in mutual funds.