Captured Money? Differences in the Performance Characteristics of Retail and Institutional Mutual Funds

Abstract

Since the early 1990s, a number of mutual funds have emerged that cater exclusively to institutional investors, i.e. pension funds, trusts and corporate benefit plans. Information on the performance and flows into institutional mutual funds provides a unique opportunity to compare the factors influencing investment decisions of institutional investors to those of individual retail investors. We find that despite significantly lower expenses, on average institutional funds do not outperform retail funds. In addition, investors in institutional funds do not chase returns the same way that retail customers do. One explanation for the lack of any flow performance relationship is that some investors in these funds do not closely monitor the investment decisions made on their behalf by trustees and other institutional money managers. We refer to this as the capture hypothesis. To test the capture hypothesis we split institutional funds based on investor clientele and minimum investment requirements (a proxy for the costs of monitoring). Consistent with the capture hypothesis, we find institutional funds with relatively low investment requirements and funds with retail mates perform worse than other institutional funds both before and after adjusting for risk and expenses. Moreover, while cash flows into institutional funds are less sensitive to fund performance than are flows into retail funds, flows into institutional funds with high investment requirements are significantly more sensitive to risk-adjusted measures of performance than flows into retail funds. This suggests that some institutional investors focus on different performance criteria than retail investors.