Mutual fund families often launch trendy products for the sole purpose, unsurprisingly, of attracting assets.
A recent paper from two academics finds that mutual funds have “incentives to cater to investor sentiment to attract assets under management by launching trendy mutual funds.”
The incentives, Jason Green from the University of Alabama and Jeffrey Stark of Bridgewater State write, exist regardless of whether the fund sponsor is skilled or can outperform.
“Newly launched trendy funds generate significant additional inflows in their first twelve months, yet underperform over their first five years compared to non-trendy funds,” they add in typical understated language. “Our results suggest that mutual fund launches appear to be motivated by considerations other than skill.”
The authors created “a measure of investor sentiment to determine what fund names are trending.” The measure of trendiness is derived by parsing fund names to determine which words receive the most fund flows in a given period.
“We associate this measure of trendiness with subsequent periods’ fund flows and show that our measure explains a significant portion of the variation in fund flows even after controlling for fund-specific characteristics, prior performance, and prior fund flows.
“The implicit assumption of most studies of mutual fund performance is that funds are launched with an expectation of skill,” they conclude. “In contrast, our results suggest that fund launches may be motivated by demand considerations, rather than skill expectations 25 alone. Our findings help explain why studies of mutual fund performance find mixed evidence of superior skill in managing portfolios in the overall population of mutual funds.”