Conflicts of Interest and Mutual Fund Performance: Evidence from Investment Banking Relationships

Abstract

This paper examines the effect of conflicts of interest on the performance of investment bank affiliated mutual funds. We find robust evidence that affiliated funds underperform unaffiliated funds. An important source of this underperformance is the disproportionately large holdings of investment banking clients' stocks by affiliated mutual funds. The average holding of client stocks by affiliated funds is more than twice as large as their average holding of non-client stocks. More importantly, the client holdings of affiliated funds underperform both their benchmarks and non-client holdings, consistent with the long-run underperformance of equity issuers and acquirers documented in prior literature. The underperformance of affiliated funds cannot be explained by lack of investor monitoring for fund performance, nor is it mitigated by investment bank reputation. Our results are consistent with the idea that investment banks use affiliated funds as a tool to support underwriting and advising business at the expense of fund shareholders.