BAFI Academic Seminar

Which Risk Factors Matter to Investors? Evidence from Mutual Fund Flows

When selecting an actively managed equity fund, investors seek to identify fund managers who are able to generate positive risk-adjusted performance (alpha). To assess risk-adjusted performance, investors must apply a model of risk when ranking funds; thus, we can infer the risk model that investors use by the fund choices that they make.  Based on this observation, we analyze the sensitivity of fund flows to alphas calculated using competing models of risk: market-adjusted returns, the Capital Asset Pricing Model (CAPM), the Fama-French three-factor model (which adds size and value factors), and the Carhart four-factor model (which adds a momentum factor). We first find that the CAPM-based alpha better explains fund flows than the three- or four-factor alphas. We then decompose fund returns into five categories – (1) four-factor alpha and returns that can be traced to the (2) market (beta), (3) size, (4) value, and (5) momentum tilts of the fund. We find that investors are most sensitive to a fund’s alpha. Fund returns that can be traced to size, value, or momentum are discounted, but not much (with sensitivities ranging from 63-93% of that observed for alpha). However, fund returns that can be traced to the market beta of the fund are heavily discounted (with a sensitivity that is 26% of that observed for alpha). These results indicate that investors care about market risk when evaluating mutual funds, but most do not treat other factor returns as compensation for risk when evaluating the performance of actively managed mutual funds. We also find that investors respond strongly to the market-adjusted return of a fund’s Morningstar category suggesting that investors may confuse strong category performance with fund manager skill.


Fee: [Yes/No/Varies]

Contact Information:
Tedda Nathan
Dept. Administrator, Dept. of Banking & Finance
txn2@case.edu
216-368-2040
216-368-6249

Friday, Sep. 19, 2014 from 10:30 a.m. to noon
03 Peter B. Lewis Building
11119 Bellflower Road
Cleveland, OH 44106-7235
United States
Speaker(s): Brad M. Barber, UC Davis
Sponsored by: Banking & Finance
Barber paper

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