Jon A. Fulkerson

Return Chasing in Bond Funds

We use a unique dataset of SEC Form N-SAR filings to examine the gross flows of U.S. bond funds. We find that gross inflows and outflows average around 4% of total net assets per month, but net flows average only 0.26%. When modeling these flows, we see that, as with equity funds, bond fund investors chase returns. Most of the return chasing is done by inflows. Funds with the highest decile of returns average 1% higher net flow and inflow per month, and the lowest-decile funds lose nearly 0.6% in assets per month. Next, we find that positive net flows cause bond funds to diversify their holdings regardless of fund size. Finally, we test whether flows predict returns and find that an inflow-weighted portfolio generates alphas of 0.8% per year. Bond inflows appear to be “smart money.”

Risk and Fund Flows

We study the impact of risk on mutual fund flows. Consistent with prior literature, we find evidence that net flows show aversion to risk. We show, however, that gross inflows and outflows are positively related to risk. While this result appears rational for outflows, it appears anomalous for inflows. We find that inflows are positively related to idiosyncratic risk, rather than systematic risk, and that institutional investors and incumbent investors are less susceptible to this behavior. Our results extend a growing body of evidence that finds certain investors making sub-optimal investment decisions, such as buying past winners, regardless of risk.Using an extensive database compiled from SEC N-SAR filings, we study how risk affects monthly flows to equity mutual funds over the period 1996 to 2009. Unlike most previous studies, we separately examine inflows, outflows, and net flows. We find that both retail and institutional investor inflows and outflows strongly chase past raw performance, but more importantly, they do so without regard to risk. This behavior appears to neither help nor harm investors, but it has significant implications for fund managers. Among other things, the welldocumented inability of fund managers to produce significant abnormal returns may be due to incentives rather than lack of skill or market efficiency.

Reading Tomorrow’s Newspaper: Predictability in ETF Returns

We study the persistence of ETF premiums and discounts. Following a day of high or low premiums, or premiums or discounts over NAV, ETFs tend to maintain a premium or discount for as many as five days, though there is some regression to the mean. Premiums also predict distinct patterns of returns on the following day. Overnight prices drop following a high premium, but high-premium ETFs have significantly higher returns the next day. Surprisingly, the NAV returns over the next day also tend to be positive. Discounts show a similar but opposite pattern, with smaller magnitudes. We conclude that ETF premiums and discounts have some ability to predict future returns, including the fundamental returns of the underlying assets.

Predictability in Bond ETF Returns

This article studies the persistence of bond exchange-traded fund (ETF) premiums and discounts. Following a day of high or low premiums or discounts over net asset value (NAV), ETFs tend to maintain a premium or discount for up to 30 days. Premiums and discounts also predict distinct patterns of returns after daily closing. Overnight returns are negative following a high premium, while ETFs with large discounts are followed by positive overnight returns. The large discount ETFs have substantially higher returns than high premium ETFs over the subsequent thirty days. We find that traditional liquidity measures, along with prior deviations from NAV, are significant in explaining a fund’s premiums/discounts. Finally, we examine a long–short portfolio strategy to exploit the observed deviations from NAV and find it generates an alpha of 0.96% per month or about 11.5% per year.

Investment Restrictions and Fund Performance

We examine why mutual funds appear to underperform hedge funds. Utilizing a unique panel of mutual fund contracts changes, we explore several possible channels, including: alternative investment practices (e.g., short sales and leverage), performance-based compensation, and the ability to restrict the funding risk of fund flows. We document that over our sample period, mutual funds were more likely to shift their contracting environment closer to that of hedge funds. However, this shift provided no benefit to mutual funds and we find no causal link between these contract changes and improvements in performance. Rather, our results cast doubt on the binding nature of investment restrictions in the mutual fund industry.

Portfolio Concentration and Mutual Fund Performance

Mutual fund managers should choose to increase the concentration of their portfolio when they possess information of great enough expected value to offset the risks of increased concentration. Consistent with that idea, we find that fund performance improves after concentration increases. Because the riskiness of increased concentration varies between funds and over time, the expected value of the information required by managers before choosing to increase concentration should also vary. Among other results, we show that the concentration-performance relation is stronger for funds with less institutional ownership and when investor sentiment is low.

Are Bond ETF Investors Smart

Since their introduction in 2002, bond ETFs have grown dramatically, with more than

Challenging the Conventional Wisdom on Active Management: A Review of the Past 20 Years of Academic Literature on Actively Managed Mutual Funds

243 billion in assets by the end of 2012. Using data on gross flows from N-SAR filings, we provide the first comprehensive examination of bond ETF characteristics and cash flows. We find evidence of return chasing in the net flows of some fund styles; in particular, investment grade corporate, international, and TIPS funds. In addition to past returns, other factors related to fund flows are fund size, expense ratio, and premium/discounts. We also examine the relationship between short interest and fund flows, and find that lightly shorted funds have both lower inflows and net flows. Finally, we test if bond ETF investors optimally time their purchases and sales. We find evidence of smartness in the timing of ETF sales, with investors earning 30 basis points in alpha per month.

Bond ETF Arbitrage Strategies and Daily Cash Flow

Just over 20 years have passed since the publication of Mark Carhart’s landmark 1997 study on mutual funds. Its conclusion—that the data did “not support the existence of skilled or informed mutual...

Search Costs and Revealed Preferences for Idiosyncratic Volatility

Bond ETFs trading at a premium (discount) to NAV experience more creations (redemptions) than those trading at parity. When these transactions occur, subsequent returns partially offset the premium or discount. These results suggest that arbitrage trading between the underlying bonds and the ETFs has a significant impact on market returns. However, in the absence of cash flow, premiums and discounts persist. The authors consider market factors that discourage arbitrage trading around premiums and discounts, and find these anomalies persist in part due to costs and uncertainty in the secondary market.