Abstract
The existence of a “smart money” effect has been debated since Gruber (1996) and Zheng (1999) suggested investors select mutual funds that subsequently perform well. Using hand-collected data on monthly inflows and outflows, we examine the relation between fund flows and subsequent fund performance in the U.S. mutual fund market. Our results indicate that investors make smart choices when selecting mutual funds. In particular, their money flow into small funds and money flow out of large funds strongly predict future performance. The effects are robust after controlling for a momentum effect. We also show that investors’ fund selection ability exists even in top-performing funds, which means that the smart money effect is separate from investors’ return-chasing behavior.
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