Time-Varying Mutual Fund Performance-Flow Sensitivity and Managerial Effort

Abstract

It is well-documented that mutual fund flows are positively related to funds’ past performance. This paper focuses on the time-series variation of the performance-flow relationship. I find that investors are more sensitive to fund performance in some periods than other periods and that the sensitivity difference is statistically and economically significant. The variation in sensitivity could be driven by many factors, including the signaling value of fund performance, investor attention, and wealth shocks. Furthermore, a large part of change in sensitivity is predictable based on public information. The variation in sensitivity could affect managers’ incentives: the payoff for managerial effort is high in a high-sensitivity period. The panel regression results show that managers will work harder when expected sensitivity is high, which is reflected by a larger deviation from benchmark index holdings, more trading, and more information collection. The results are robust to alternative explanations and out-of-sample test.