Smart Fund Managers? Stupid Money?

37 Pages Posted: 10 May 2004 Last revised: 7 Aug 2008

See all articles by Dan Bernhardt

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics

Ryan J. Davies

Babson College - Finance Division

Multiple version iconThere are 2 versions of this paper

Date Written: August 5, 2008

Abstract

We develop a model of mutual fund manager investment decisions near the end of quarters. We show that when investors reward better performing funds with higher cash flows, near quarter-ends a mutual fund manager has an incentive to distort new investment toward stocks in which his fund holds a large existing position. The short-term price impact of these trades increase the fund's reported returns. Higher returns are rewarded by greater subsequent fund inflows which, in turn, allow for more investment distortion the next quarter. Because the price impact of trades is short-term, each subsequent quarter begins with a larger return deficit. Eventually, the deficit cannot be overcome. Thus, our model leads to the empirically observed short-run persistence and long-run reversal in fund performance. In doing so, our model provides a consistent explanation of many other seemingly contradictory empirical features of mutual fund performance.

Keywords: turn-of-quarter effect, painting the tape, mutual fund performance, investment distortion

JEL Classification: D82, G2, G14

Suggested Citation

Bernhardt, Dan and Davies, Ryan J., Smart Fund Managers? Stupid Money? (August 5, 2008). Available at SSRN: https://ssrn.com/abstract=428088 or http://dx.doi.org/10.2139/ssrn.428088

Dan Bernhardt

University of Illinois at Urbana-Champaign - Department of Economics ( email )

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Ryan J. Davies (Contact Author)

Babson College - Finance Division ( email )

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United States
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