Business Cycle and Investment Flows of Retail and Institutional Mutual Funds

Abstract

Purpose: I investigate the dynamics of mutual fund investment flows across the business cycle. To account for the differences in the flow patterns of funds catered for institutional investors and those focusing on retail investors, I conduct my investigation separately for flows of institutional and retail funds.

Design/methodology/approach: I use the sample of U.S. equity mutual funds for the period between 1999 and 2012. For the samples of each type of fund, I perform separate analyses for expansion and recession periods. Following Sirri and Tufano (1998), I implement the Fama MacBeth (1973) approach.

Findings: I find that flow patterns of both fund types vary across the business cycle. For example, my results reveal that during bad times, institutional investors demonstrate weaker return-chasing behavior, while paying higher attention to Jensen’s alpha, than during good times. In addition, I report results on the effect of fund exposure to various systematic risk factors. For instance, I observe that during economic downturns, investors of both fund types tend to punish managers with higher market exposure. During expansions, the fund’s market exposure positively affects flows of institutional funds, while its effect on the flows of retail funds remains negative.

Originality/value: To the best of my knowledge, this is the first study that investigates mutual fund investment flow patterns across the business cycle, while simultaneously accounting for differences in flow patterns between retail and institutional funds. A further contribution of this paper is that it explores the previously-overlooked relationships between fund flows and their exposure to various systematic risk factors.

Keywords: mutual funds, business cycle, institutional investors, retail investors, institutional funds, retail funds, investment flows

JEL Classification: G02, G11, G23