Net Fund Flows Research Articles

The Impact of ESG Ratings on Exchange-Traded Fund Flows

The aim of our paper is to examine the impact of environmental, social, and governance (ESG) ratings on investment decisions in the pre-pandemic US bond and equity exchange-traded fund (ETF) markets. We measure the attractiveness of investments in the ETF as net fund flows and estimate whether the attractiveness varies with the ESG score. For empirical estimations, we employ the regression analysis methodology; specifically, we use linear mixed-effect model to analyze time-series dataset and ordinary least squares to analyze the cross-section data. On the one hand, we found that, on average, ETFs which comply with ESG criteria attracted additional net assets per month as compared to conventional ETFs. Thus,the results of our study indicate that investors demonstrate collective preference towards ESG investments and pay attention to the information on whether the ETF complies with the ESG criteria. On the other hand, we found mixed evidence that higher ESG score always leads to larger investments: differences in scores could not explain the variation in net fund flows. Overall, our study shows that ETF market investments are not directed by the risk-return profile only, and investors also have non-pecuniary motives for their decisions. The results have several practical implications. First, our findings offer business entities useful insight into the fact that incorporation of ESG policy can increase the attractiveness of their business for potential investors. Second, it shows that the market participants would benefit from increasing transparency and unification of rating methodology.

Performance Evaluation Disagreement

This paper studies investor disagreement in the performance evaluation of equity mutual funds by comparing two existing approaches and estimating its relations with fund characteristics, active management level and fund flows. We find that investors disagree more about the performance of funds that have higher expense ratio and turnover, lower manager tenure and dividend yield, and that are older, smaller and part of a larger family. Disagreement is also higher for funds that follow riskier investment style strategies and deviate more from their benchmarks. Finally, larger disagreement leads to more net fund flows. These findings suggest that heterogeneous investors do not value funds with aggressive active trading strategies similarly, and that favorable valuations by some clienteles result in positive demands for this type of management.

Economic demand for auditing services in the “registered” investment management industry

AbstractWe hypothesize that the demand for auditing in the registered investment management industry arises from the auditor's ability to act as a solvent indemnifier when outside parties incur losses because of financial misrepresentations. Consistent with this insurance demand, we find that, relative to financial companies, registered investment companies are more likely to retain Big 4 auditors. Restricting the sample to the registered investment management industry, we construct three direct tests of the insurance demand hypothesis. We find that (a) the market share of a Big 4 firm is positively associated with the firm's wealth, (b) changes in audit fees are positively associated with changes in the audit firms’ wealth, and (c) net fund flows increase when clients switch from non‐Big 4 to Big 4 auditors. Our results highlight an unusually high demand for Big 4 auditors in the registered investment industry, which we attribute to the insurance demand for auditing services.

Investor response to Morningstar's ratings, category information, and alpha in the Japanese mutual fund market

Mutual fund investors evaluate fund managers' skills before making investment decisions. Previous studies worldwide examined the rationale behind retail investors' investment decisions and found that investors reward performance by net fund flow. A Japanese study found that investors respond to alpha but do not risk factor-related returns. Surprisingly, the result would mean that Japanese investors are more sophisticated than US investors because the literature reported that US investors respond to factor-related returns without distinguishing them from alpha. We explore the background of this result in the Japanese market. This study focuses on the effects of Morningstar's fund ratings, its categories, and salient gross returns, which are readily available to investors unlike alpha. We find the following results: (1) Morningstar's rating does not substitute alpha, indicating that our result differs from the US results. (2) Investors respond only to high category excess returns, but it is a unique effect different from alpha. (3) Salient gross returns do not have a concrete relation with alpha. Moreover, we find solid convex relationships between alpha and fund flows. Investors' responses are limited to a few extreme flows; other than these, they do not respond to alpha. This extreme flow can explain the reactions to alpha on average reported in previous studies. In addition, we find that the category excess return has similar features. The solid convexity reveals that the Japanese mutual fund market is far from sophisticated, consistent with the literature. These results reveal the importance of fund distributors' behavior and information disclosure regulations.

Are socially responsible exchange‐traded funds paying off in performance?

AbstractThis study examines the Socially Responsible (SR) exchange‐traded funds (ETFs) by comparing their risk‐adjusted performance with a matched group of conventional ETFs in the U.S. equity market. In contrast to prior studies that focus on actively managed mutual funds, we find that the risk‐adjusted returns of SR ETFs are significantly lower than those of conventional ETFs during the 2005–2020 period. Such underperformance is only observed in non‐crisis periods but not in economic crisis periods (i.e., the 2020 pandemic recession and 2008 financial turmoil). We attribute the observed underperformance of SR ETFs during the non‐crisis periods to their limited diversification of unsystematic risks resulting from various negative or positive screens employed in the funds. We also find that net fund flows of the SR ETFs are less sensitive to past negative performance than are conventional fund flows. Collectively, our findings suggest that, instead of seeking wealth maximization, socially conscious investors may choose SR ETFs to gain non‐economic utility.

The Portfolio Composition Effect

Does the evaluation of a portfolio of stocks depend on its composition of winner and loser stocks? To test this, we define a simple, counting-based measure of performance - the number of winner relative to the number of loser stocks in a portfolio - and examine how this composition measure affects individuals' willingness to invest in a portfolio. We derive testable predictions for the proposed composition measure from a framework which combines category-based thinking with mental accounting. Consistent with our predictions, we find across all experiments that individuals allocate larger investments to portfolios with more winner than loser stocks relative to alternative portfolios with more loser than winner stocks, although both portfolios (1) have realized identical overall portfolio returns and (2) show identical expected risk-return characteristics. Building on our experimental findings, we analyze fund flows of exchange-traded funds on leading equity market indices. We identify that the proposed portfolio composition measure is positively related to future net fund flows.

Modeling and analysis of the effect of COVID-19 on the stock price: V and L-shape recovery

The emergence of the COVID-19 pandemic, a new and novel risk factor, leads to the stock price crash due to the investors’ rapid and synchronous sell-off. However, within a short period, the quality sectors start recovering from the bottom. A stock price model has been developed to capture the price dynamics during shock and recovery phases of such crisis. The main variable and parameter of the model are the net fund flow (Ψt) due to institutional investors, and financial antifragility (ϕ) of a company, respectively. We assume that during the crash, the stock price fall is independent of the ϕ. We study the effects of shock length (TS) and ϕ on the stock price during the crisis period using the Ψt obtained from both the synthetic fund flow data and real fund flow data. We observed that the possibility of recovery of stock with ϕ>0, termed as quality stock, decreases with an increase in TS beyond a specific period. A quality stock with higher ϕ shows V-shape recovery and outperform others. The TS and recovery period of quality stock are almost equal in the Indian market. Financially stressed stocks, i.e., the stocks with ϕ<0, show L-shape recovery during the pandemic. The stock data and model analysis show that the investors, in the uncertainty like COVID-19, invest in the quality stocks to restructure their portfolio to reduce the risk. The study may help the investors to make the right investment decision during a crisis.

Mutual fund asset allocation during COVID-19

The paper examines the investment decisions of equity mutual funds during various stages of the COVID-19 pandemic with monthly portfolio holdings. We find that funds have favored firms with lower risk, higher financial flexibility, and larger asset size during the early months of the pandemic. This preference for relatively less risky firms, which later reverses, suggests a reallocation towards safer assets given the higher uncertainty at the beginning of the crisis. We also find that funds preferred growth firms over value firms as value firms with greater invested capital are likely to be less resilient to the crisis-induced shock. Institutional investors have also favored group-affiliated firms throughout the crisis, reflective of their ability to negotiate through the protracted economic shock. Furthermore, our fund-level analysis reveals that the investment approach of funds strongly varied by the extent of the net fund flows. The paper brings out key firm- and fund-level characteristics that impact the asset allocation of institutional investors during extreme market uncertainty.

Introduction to a Special Issue of the Financial Planning Review on financial technology

Introduction to a <i>Special Issue</i> of the <i>Financial Planning Review</i> on financial technology

Stock returns and mutual fund flows in the korean financial markets: a system approach

ABSTRACT This paper investigates dynamic and causal relations between stock returns and mutual fund flows in Korea using a system method that utilizes information from the stock, bond, and money markets. For this purpose, we employ the Dynamic Seemingly Unrelated Regression, the Seemingly Unrelated Regression Error Correction Model, and two causality tests in a system method to account for cross-equation correlations among markets that have a close relationship with one another. Furthermore, we use the information in the variance-covariance matrix of residual to improve the efficiency of the statistical estimates. The empirical evidence from the system method indicates that fund flows do not respond to eliminate deviations from long-run equilibrium, and stock prices cause net fund flows in the Korean market, implying that investors move their money to the securities that yield higher returns to rebalance their investment portfolios in the short-run. Thus, our findings do not support the popular notion of mutual fund flows as the driving force behind rallies in the Korean financial markets.

Stock Returns and Mutual Fund Flows in the Korean Financial Market: A System Approach

This paper investigates dynamic and causal relations between stock returns and mutual fund flows in Korea using a system method which utilizes information from the stock, bond, and money markets. For this purpose, we employ DSUR proposed by Mark, Ogaki, and Sul (2005), SURECM, and two causality tests by Granger (1969) and Sims (1972) in a system method to account for cross equation correlations among markets which have a close relationship with one another. Furthermore, we make use of information in the variance-covariance matrix of residual to improve the efficiency of the statistical estimates. The empirical evidence from the system method indicates that fund flows do not respond to eliminate the deviation from long-run equilibrium, and stock prices cause net fund flows in the Korean market, implying that investors move their money to the securities that yield higher returns to rebalance their investment portfolios in the short-run. Thus, our findings do not support the popular notion that considers mutual fund flows as a driving force behind rallies in Korean financial markets.

The Portfolio Composition Effect

Does the evaluation of a portfolio of stocks depend on its composition of winner and loser stocks? To test this, we define a simple, counting-based measure of performance - the number of winner relative to the number of loser stocks in a portfolio - and examine how this composition measure affects individuals' willingness to invest in a portfolio. We derive testable predictions for the proposed composition measure from a framework which combines category-based thinking with mental accounting. Consistent with our predictions, we find across all experiments that individuals allocate larger investments to portfolios with more winner than loser stocks relative to alternative portfolios with more loser than winner stocks, although both portfolios (1) have realized identical overall portfolio returns and (2) show identical expected risk-return characteristics. Building on our experimental findings, we analyze fund flows of exchange-traded funds on leading equity market indices. We identify that the proposed portfolio composition measure is positively related to future net fund flows.

The Role of the Local Information Demand for Cross-Listed Securities: Evidence From European Cross-Listed ETFs

We investigate how the local information demand explains the market outcomes in cross-listed European Exchange Traded Funds (ETFs). Our results show that the local information demand predicts the future trading volume and, to a lesser extent, the future net fund flows. The effects of the information demand are much stronger when the institutional ownership of the traded ETF is low. Our evidence implies that retail investors, unlike institutional investors, trade and process information regarding securities locally regardless of the domicile of the underlying investment. Our findings hence lend support to the perceived role of familiarity bias, although its prominence and impact vary between countries.

Who benefits in a crisis? Evidence from hedge fund stock and option holdings

We use a unique data set of hedge fund long equity and equity option positions to investigate a significant lockup-related premium earned during the tech bubble (1999–2001) and financial crisis (2007–2009). Net fund flows are significantly greater among lockup funds during crisis and noncrisis periods. Managers of hedge funds with locked-up capital trade opportunistically against flow-motivated trades of non-lockup managers, consistent with a hypothesis of rent extraction in providing crisis era liquidity. The success of this opportunistic trading is concentrated during periods of high borrowing costs, in less liquid stock markets, and is enhanced by hedging in the equity option market.

Relative Liquidity, Fund Flows and Short‐Term Demand: Evidence from Exchange‐Traded Funds

AbstractWe show that highly liquid Exchange‐Traded Funds (ETFs), especially those that are more liquid than their underlying basket of securities (i.e., positive relative liquidity), are particularly attractive to investors. Using three definitions of liquidity, we find that relative liquidity predicts net fund flows, as well as inflows and outflows positively and significantly. We further document a liquidity clientele among institutional investors: (i) relative liquidity is significantly more important for short‐ than for long‐term investors; and (ii) relative liquidity is inversely related to investors’ average holding duration in the ETFs. These two findings provide evidence that relative liquidity encourages short‐term demand.

The Determinants of Aggregate Fund Flows to Emerging Markets. A Push-Pull Analysis

This paper investigates how cyclical variables drive net aggregate fund flows towards emerging markets (EMs). Through the aggregation of net flows of all open-end dedicated funds, the analysis finds that flows in equity and fixed income are driven by recent past performance in both developed and emerging economies. Further analysis confirms that much of the evidence comes from US and EU larger mutual funds. A structural VAR shows that flows become more responsive through time to market uncertainty and rates. In particular, after the Great Recession flows exhibit a lower reaction to the S&P index, becoming more responsive to market volatility and to US interest rates. Furthermore the US consumer sentiment index has a key role in the explanation of fund flows and it increased through time with an effect that is more sluggish and persistent with respect to other cyclical variables.

Equity Fund Flows and Performance around Economic Recessions

The relation between net fund flows and performance is examined around the two most recent U.S. economic recessions for U.S. equity funds. Post-recessionary period net fund flows are positively (negatively) correlated with absolute (peer-relative) performance for the early 2000s recession, and with absolute and peer-relative performance for the Great Recession (the most recent one) according to nonparametric measures. Empirical copulas in the extreme left tails indicate a positive dependence for the early 2000s recession, and independence for the Great Recession between performance and net fund flows.

Analysis of the factors impacting ETFs net fund flow changes

Purpose The purpose of this study is to identify the factors that impact the exchange-traded funds net fund flow changes on a daily basis. Design/methodology/approach A total of 1,212 different exchange-traded funds with a proprietary daily net fund flow data and logistic regressions were studied because the majority of the 1,212 exchange-traded funds have mostly zero daily net fund flow changes. Findings It was documented that in the period December 22, 2005 to July 28, 2010 autocorrelation at the daily frequency is not universally present for the 1,212 exchange-traded funds that we study, despite the fact that this is the case in the monthly data documented in prior studies. No support was found for the feedback trading hypothesis but some support was found for the contrarian investor hypothesis on daily basis, even though the opposite is ascertained for both in the prior literature monthly data. Also, it cannot be concluded that tracking error prompts net fund flow changes and thus arbitrage activity. Originality/value The paper contributes to the ongoing analysis of the factors influencing investment companies fund flow changes, which has mostly focused on open-end funds and monthly data so far. Considering the increased scope and relevance of exchange-traded funds in today’s financial markets, this study fills a void in the fund flow changes literature.

Who Benefits in a Crisis? Evidence from Hedge Fund Stock and Option Holdings

We use a unique data set of hedge fund long equity and equity option positions to investigate a significant lockup-related premium that is earned during the Tech Bubble and Financial Crisis. Net fund flows are significantly greater among lockup funds during both crisis and non-crisis periods. Managers of hedge funds with locked up capital trade opportunistically against flow-motivated trades of nonlockup managers, consistent with a hypothesis of rent extraction in provision of crisis era liquidity. Moreover, the success of this opportunistic trading is concentrated in less liquid stock markets and enhanced by hedging in the equity option market.

Derivative Uses of Equity Funds and Net Fund Flows

Derivative Uses of Equity Funds and Net Fund Flows