[We relate the performance of mutual fund trades to their motivation. A fund manager who buys stocks when there are heavy investor outflows is likely to be motivated by the belief that the stocks are significantly undervalued. In contrast, when there are heavy inflows, the manager is likely to be motivated to work off excess liquidity by buying stocks. Our analysis reveals that managers making purely valuation-motivated purchases substantially beat the market but are unable to do so when compelled to invest excess cash from investor inflows. A similar, but weaker, pattern is found for stocks that are sold.]

This is the first study of corporate bond mutual fund performance that examines detailed security-level holdings and returns. The new database allows us to decompose the costs and benefits of active management. In contrast to prior research on equity funds that shows evidence of stock-selection ability, we do not find evidence consistent with bond fund managers, on average, being able to select corporate bonds that outperform other bonds with similar characteristics. We find neutral to weakly positive evidence of ability to time corporate bond characteristics. Overall results show that the costs of active management on average appear larger than the benefits.

This study examines the performance of mutual funds managed by firms that simultaneously manage hedge funds. We find that the reported returns of mutual funds in these “side-by-side” associations with hedge funds significantly underperformed those of mutual funds that shared similar fund and family characteristics but differed in that they were not affiliated with hedge funds. Digging deeper into performance, we find that the underperformance was confined to return gaps, a return measure that captures the impact of unobservable managerial actions. Interestingly, mutual funds with investment styles that were most closely aligned to affiliated hedge funds generated reported-return alphas and return gaps that underperformed by the greatest amount. Finally, we find that side-by-side mutual funds received less of a contribution to performance from IPO underpricing than similar unaffiliated mutual funds or affiliated hedge funds. Evidence does not support the hypothesis that affiliations with hedge funds allow side-by-side mutual funds to attract superior stock-picking talent. Our evidence does not allow us to rule out the possibility that management firms maximized fee income by strategically transferring performance from mutual funds to hedge funds.

Previous empirical studies that decompose the bid-ask spread were done when securities traded in discrete price points equal to one-sixteenth or one-eighth of a dollar. These studies concluded that inventory and adverse-selection costs were economically insignificant compared to order-processing costs. Natural questions arise as to: (i) whether price discreteness allowed market makers to enjoy excess rents, thus reducing the significance of the inventory and adverse selection costs; (ii) whether discreteness decreased the traders' incentives to gather information; or (iii) whether methodologies previously employed mis-estimated the inventory and the adverse-selection costs. We show that the recent conversion to decimal pricing results in significantly tighter spreads. However, the dollar value of spreads attributed to adverse selection and inventory costs do not change significantly. Almost all of the reduction occurs in the order-processing component. As a result, inventory and adverse-selection costs now account for a significantly larger proportion of the traded spreads. A plausible explanation is that the minimum tick size constraint previously in place under fractional pricing allowed market makers to enjoy spreads that were larger than their actual costs.

Scott Gibson, Assem Safieddine, Sheridan Titman, Tax-Motivated Trading and Price Pressure: An Analysis of Mutual Fund Holdings, The Journal of Financial and Quantitative Analysis, Vol. 35, No. 3 (Sep., 2000), pp. 369-386

We document that seasoned equity issuers experiencing the greatest increase in institutional investment around the offer date outperformed their benchmark portfolios in the year following the issue by a statistically and economically significant margin relative to those experiencing the greatest decrease. No such relationship exists for a control sample of matched non-issuers. Issuers with the greatest institutional investment are also found to have the highest ratio of sell-side analyst upgrades less downgrades to total forecasts in the two quarters following the issue. Again, no such relationship is found for matched non-issuers. We interpret our results as evidence that institutions are able to identify above-average seasoned equity offering SEO firms at the time of equity issuance and increase their holdings in these potential outperformers.

We study the dispersion of month-end valuations placed on identical corporate bonds by different mutual funds. Such dispersion is related to bond-specific characteristics associated with liquidity and market volatility. The Trade Reporting and Compliance Engine (TRACE) could have contributed to the general decline in dispersion over our sample period, though other factors most likely played roles. Further tests reveal marking patterns to be consistent with returns smoothing behavior by managers. Funds with ambiguous marking policies and those holding “hard-to-mark” bonds appear more prone to smooth reported returns. From a regulatory perspective, we see little downside to requiring funds to explicitly state their marking standards.

We relate the performance of mutual fund trades to their motivation. A fund manager who buys stocks when there are heavy investor outflows is likely to be motivated by the belief that the stocks are significantly undervalued. In contrast, when there are heavy inflows, the manager is likely to be motivated to work off excess liquidity by buying stocks. Our analysis reveals that managers making purely valuation-motivated purchases substantially beat the market but are unable to do so when compelled to invest excess cash from investor inflows. A similar, but weaker, pattern is found for stocks that are sold.