What Happens After a Fund Family Begins to Offer ETFs?

Abstract

Motivated by a growing trend where the increasing number of conventional mutual fund families have begun to offer exchange-traded funds (ETFs), we study the effects of ETFs on the actively managed mutual funds (active funds) in the same mutual fund family. Our difference-in-difference investigations and placebo test reveal a significant reduction in the performance of the affiliated active funds after a fund family begins to offer ETFs. To explain this finding, we propose the brand name hypothesis, which posits that issuing ETFs and the accompanying increase in advertising enhance the brand name of a fund family and its affiliated mutual funds. As investors value brand names in addition to the performance of mutual funds, enhancing the brands would lower the fund flow-performance sensitivity. Hence, the incentive and effort to actively manage funds would also decrease. Indeed, the evidence supports this hypothesis. We also find an increase in the expense ratio, fund inflows, and assets under management. Overall, the revenue of active funds increases despite their deteriorating performance. The added revenue also helps to explain why traditional active mutual fund families have begun to offer popular ETFs under the same umbrella of the family’s brand name.