Swasti Gupta-Mukherjee

Limited Attention and Portfolio Choice: The Impact of Attention Allocation on Mutual Fund Performance

This study proposes that the performance of mutual fund managers is linked to how efficiently they allocate attention across assets in their investment set. Motivated by existing models of optimal portfolio choice and rational inattention, we posit that the efficiency of attention allocation increases when a manager chooses larger (smaller) active positions in assets which need more (less) information acquisition effort to resolve uncertainty about future payoffs. We show that the efficiency of attention allocation has a significantly positive impact on future fund performance. Efficient attention allocation has a lesser impact on performance as the total demands on a manager’s limited attention increase.

Investing in the “New Economy”: Mutual Fund Performance and the Nature of the Firm

Although stock returns of intangibles-intensive firms tend to exceed physical assets-intensive firms, risk-adjusted returns of actively managed mutual funds significantly decrease (increase) with their portfolios’ exposure to intangibles-intensive (physical assets-intensive) firms. Fund managers tend to exhibit skill when they focus on difficult-to-value (e.g. small) firms, except when the firms are intangibles-intensive. In sum, the worst-performing funds are in areas of the market which seem to offer ample opportunities for professional investors due to exacerbated mispricing. The negative impact of investments in intangibles-intensive firms on fund performance appears to be driven by extrapolation bias and decreases with learning from experience.

The Decline in Venture-Backed IPOs: Implications for Capital Recovery

The decline in initial public offerings (IPOs) has raised concerns about the vitality of the venture capital industry. We examine capital recovery in the VC industry using returns for 1,215 M&A and 1,401 IPO exits from U.S. based venture-backed companies during 1985 to 2008. We find that mean and median returns for IPO exits are significantly higher than M&A exits, with the median M&A exit having a negative return. A decomposition of returns into its fundamental components − investor stakes, capital allocated to portfolio companies (money-in), and capital recovered from portfolio companies (money-out) − shows that returns are five times more sensitive to money-in than money-out, with more disciplined capital allocation being especially important for generating high M&A returns. In all market conditions, IPOs have average exit returns in excess of 125% whereas M&A returns are lower and exhibit more variation. Taken together, the results suggest that it is more difficult to achieve outsized returns from M&A than IPO exits. For the industry as a whole, the dollars realized from M&A exits do not keep pace with their growth as a proportion of total exits over time. Increasing numbers of exits must be produced to recover the total capital at risk, suggesting that industry concerns about a decline in IPO exits and their likely higher capital recovery are well-founded.

On the Implications of Mutual Fund Managers’ Reliance on Categories

Psychologists commonly believe that categorization, i.e. grouping many subjects into a few broad categories, is elemental to thinking. This study shows that the categorization of assets into coarse groups (e.g. industries, styles) is associated with some portfolio investors exhibiting categorical thinking– thinking where investors emphasize category-wide information and ignore asset-specific information during investment decisions in assets. To discern whether such categorical thinking in portfolio decisions reflects an information-processing bias that has potentially negative economic effects, I propose the following three hypotheses. First, psychological evidence predicts that if categorical thinking is an information-processing bias, it should increase with information uncertainty and complexity. Second, if a portfolio investor’s categorical thinking is an information-processing bias, it should lead to forecasting errors about asset values and, thus, should be negatively related to portfolio performance. Third, if categorical thinking leads to biased forecasting, portfolio investors should display less (more) skill in valuing assets with more (less) coarse categorizations, i.e. for which the category-wide information is less (more) informative. Based on actively managed equity mutual funds, the empirical results strongly support these hypotheses. The findings link an information-processing bias arising from categorization to the quality of decision-making in financial markets where asset categorization is pervasive.This study shows that mutual fund managers vary in their reliance on category-level information, relative to firm-specific information about assets. Moreover, fund performance decreases with managers’ propensity to rely on categories. Fund managers display less skill in picking stocks which are more coarsely categorized, especially when the managers rely more on categories. Fund managers’ reliance on categories increases with the demands on their attention, such as when market uncertainty, valuation uncertainty of assets, and portfolio diversification are high. Taken together, the evidence is consistent with fund managers’ limited attention driving their reliance on coarse categories and detrimentally affecting investment outcomes.

Investment Risk Allocation and the Venture Capital Exit Market

The factors that drive the financing available to start-ups is a key issue for entrepreneurs, venture capitalists (VCs), and other investors in new ventures, especially in light of the difficult exit market the industry has faced over the last decade. We examine how the dollars gained and lost in recent exits and failures of venture-backed companies affect VCs’ risk allocations (proportion of early- versus late-stage investment) and returns over 1986-2008. Consistent with perceptions of lower profit-to-loss potential for risky investments, we find that VCs have significantly decreased the proportion of early stage investment over time. Conditional on exit, lower risk allocations at the time of investment initiation reduce the future returns from these exits, with its impact seemingly large enough to offset the positive effects of industry downsizing since 2001. In sum, we show empirically that risk allocation is an important channel by which VCs respond to market signals.

Analysts’ Use of Industry-level and Firm-Specific Information: Implications for Information Production

This paper examines security analysts’ tendency to rely on category-level (e.g. industry) information as opposed to firm-specific information in issuing earnings forecasts. We find that analysts who rely more on category-level information have larger forecast errors, issue less frequent forecasts, have less impact on stock prices, and are more likely to experience job turnover. Our results are consistent with analysts being subject to limited attention, where psychological evidence predicts that attention-constrained market participants oversimplify information processing by relying on coarse category-level information. Further, analysts’ limited attention has a significant association with their forecasting ability, stock price impact, and career outcomes.

When is Money Smart? Mutual Fund Flows, Energy Prices, and Household Disposable Income

This study shows that the representative investor’s sophistication in the market for mutual funds is time-varying, and increases with the constraints on household disposable income at the aggregate level. Based on the fact that energy commodities are largely inelastic household expenditures that reduce disposable income, I use changes in retail energy prices to proxy for short-run exogenous changes in the disposable income of potential investors. New money flows to actively managed U.S. equity mutual funds decrease with the constraints on disposable income, ceteris paribus. The representative investor shows fund selection and timing ability only in periods when the constraints on disposable income sharply increase, but does not display discernable ability unconditionally. Fund flows are more rationally sensitive to price (i.e. fees and loads) and funds’ past risk-adjusted performance when the constraints on disposable income increase. The results are also consistent with the representative fund investor displaying more aversion towards funds associated with more agency problems and inferior manager skill in periods when the constraints on disposable income increase.