Leonard Kostovetsky

Index Mutual Funds and Exchange-Traded Funds

Exchange-traded funds have proliferated in the last five years, but have not yet received much attention in the academic literature. The author explains the major differences between ETFs and their traditional index fund competitors, establishing a threshold model to compare their costs. A one-period model expanded to multiple periods helps in analysis of the sorts of investors who would prefer ETFs over index funds, and vice versa. The analysis suggests that ETFs are an especially important tool for larger investors and that long-term retail investors can also use them effectively.

You’re fired! New Evidence on Portfolio Manager Turnover and Performance

We study managerial turnover for both internally managed mutual funds and those managed externally by subadvisors. We argue that turnover of subadvisors provides sharper tests and helps address several unresolved issues and puzzles from the previous literature. We find dramatically stronger inverse relations between subadvisor departures and lagged returns, and new evidence on how past flow predicts turnover. We find no evidence of improvements in return performance related to departures, but flow improvements are associated with departures of poor past performers. Our findings represent new evidence on how investors, sponsors, and boards learn about and evaluate mutual fund management performance.

Determinants of Financial Innovation: Evidence from Mutual Funds

We study the determinants of financial innovation in the U.S. mutual fund industry, where the number of different strategies or “styles” has grown dramatically over the last several decades. We use textual analysis on each fund’s “principal investment strategies” section of the prospectus to measure its strategic uniqueness. We find that new offerings of small and new families are more likely to use unique strategies as they strive to differentiate themselves from (and compete with) larger competitors who can charge lower fees due to economies of scale. Newly opened unique funds are more likely to liquidate early than traditional funds, but also attract more flows if they are able to survive. Uniqueness also acts to attenuate the flow-performance relation, which reduces the operational risk of investor outflows that could potentially lead to asset fire sales. Our paper provides new evidence on the reasons for financial differentiation and on the role it plays in asset manager competition for investor funds.

How Much Labor Do You Need to Manage Capital

Asset management companies in the United States employ several hundred thousand people in advisory, portfolio management, and research roles, yet academic research suggests their investments, on average, underperform passive benchmarks net of fees. Using a new dataset on over 10,000 registered investment advisors (RIAs), we analyze which clienteles, asset classes, and strategies require more human capital, as well as the value that human capital adds to investment management. We find that while more human capital is not associated with better performance (controlling for assets under management), having more advisory personnel helps attract more assets, justifying their salaries from the point of view of the firm. Furthermore, larger teams actually behave more like closet-indexers, holding more diversified portfolios with lower tracking error. Our findings suggest that some active management companies realize their ability, or lack thereof, to generate alpha, and use their employees in order to keep and attract clients.