Is there an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets? Fund Performance and Subsequent Annual Fund Flows between 1997 and 2011
Aron A. Gottesman Pace University – Lubin School of Business – Department of Finance and Economics
Matthew R. Morey Pace University – Lubin School of Business – Department of Finance and Economics
Menahem Rosenberg Pace University
April 26, 2013
Abstract:
Closet indexing is the practice of staying close to the benchmark index while still maintaining to be an active mutual fund manager and probably also charging fees similar to those of truly active managers. Recent work shows active mutual fund managers were much more likely to closet index during down markets. Indeed, closet indexing became so popular that it accounted for about a third of all mutual fund assets during time surrounding 2008. In this paper we set out to answer the question of whether there actually is an incentive for mutual fund managers to closet index during down markets. To do this we examine the relationship between annual fund performance and subsequent annual fund flows in both up and down markets. Using this approach we find that the relationship between fund performance and subsequent net fund flows is significantly different in up markets years as compared to down market years. Specifically, we find that fund performance does not drive subsequent flows nearly as much in down markets as it does in up markets. Indeed, in up markets, we find a strong positive relationship between fund performance and subsequent flows. Conversely, in down years, the amount of outperformance or underperformance does not significantly influence the next year’s fund flows. Hence, based on these results, there is an incentive for active managers to closet index in down markets as investors do not reward outperformance with higher flows.
Fund managers should go into the closet when markets drop
Study finds there’s no big benefit to active management in down markets
By Michael Shagrin
July 25. 2013 3:54PM
Fund managers have every incentive to mimic their benchmark when markets are down, according to researchers at Pace University and Touro College. During up years, a strong relationship exists between fund performance and net flows. However, during down years, outperforming or underperforming a benchmark does not have a significant impact on the subsequent year’s flows. This means that “there is an incentive for active managers to closet-index in down markets, as investors do not reward outperformance with higher flows,” according to the researchers, who recently conducted a study, “Is There an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets? Fund Performance and Subsequent Annual Fund Flows between 1997 and 2011.” Read more of this post
Like this:
Like Loading...
