On the Empirical Evidence of Mutual Fund Strategic Risk Taking

We reexamine empirical evidence on strategic risk-taking behavior by mutual fund managers.Several studies suggest that fund performance in the first semester of a year influences risk-taking in the second semester.However, we show that previous empirical studies implicitly assume that idiosyncratic fund returns (in a factor model) are uncorrelated across funds.We present generalized methodologies (based on both contingency tables and regression analysis) that accommodate the case of a general error structure.We show that the correlation between idiosyncratic fund returns is essential to the analysis and, when it is taken into account, the empirical evidence of strategic risk taking by fund managers disappears.investment trusts;financial risk;financial management;performance

On the Empirical Evidence of Mutual Fund Strategic Risk Taking

We reexamine empirical evidence on strategic risk-taking behavior by mutual fund managers.Several studies suggest that fund performance in the first semester of a year influences risk-taking in the second semester.However, we show that previous empirical studies implicitly assume that idiosyncratic fund returns (in a factor model) are uncorrelated across funds.We present generalized methodologies (based on both contingency tables and regression analysis) that accommodate the case of a general error structure.We show that the correlation between idiosyncratic fund returns is essential to the analysis and, when it is taken into account, the empirical evidence of strategic risk taking by fund managers disappears.

Risk shifting consequences depending on manager characteristics

This paper investigates the performance consequences of the risk shifting behavior shown by domestic equity mutual funds through the analysis of monthly portfolio holdings. The objective of this paper is to assess the implications of risk shifting for mutual fund investors. Specifically, we study the performance consequences of different mechanisms of risk shifting, such as the change in the composition between equity and cash holdings and the change of the systematic or idiosyncratic risk within the equity positions. We find that funds that increase their risk level obtain significantly better performance than funds with stable or reduced risk levels. This finding is robust when controlling for fund characteristics such as past performance and fund size. Additionally, we examine whether the performance consequences of risk shifting depends on fund manager characteristics and find that manager gender, education and level of specialization are revealed as important variables to differentiate the performance consequences of risk shifting

Derivatives Use and Risk Taking: Evidence from Alternative Mutual Funds

I provide new empirical evidence on the effect of derivatives usage on the risk and performance of a group of mutual funds mimicking hedge fund strategies, namely alternative mutual funds (AMFs). Using data on a sample of 914 AMFs from Morningstar during 2002-2017, I show that while the use of derivatives does impact the performance of AMFs, it significantly increases AMFs’ total and idiosyncratic volatilities, even after we control for various fund characteristics. This positive relation between the use of derivatives and the risk-taking of AMFs is particularly strong during the crisis period, and Bear Market, Long-Short Credit, Managed Futures, and Multialternative funds. Overall, the result is in contrast to the documented negative or insignificant relation between derivatives usage and performance for hedge funds or traditional mutual funds, suggesting that AMFs as a group tend to use derivatives for speculative purpose

Equity-Style-Indizes und Liquidität in Europa

Contributing to the still scarce European evidence this thesis examines in detail different aspects of equity styles and systematic liquidity in Europe and their role with respect to European stocks and mutual funds. First, a consistent set of European style indices is outlined from which risk factors like market excess return, size, valuation and momentum, but also novel idiosyncratic risk and systematic liquidity factors are derived. The daily 2002 to 2009 time period examined contains the recent financial crisis. As based on a stochastic discount factor GMM based analysis, liquidity is found to help to price European stocks and a decrease in common liquidity during the recent period of market stress reveals the role of liquidity as a state variable of hedging concern to investors. Moreover, the risk factors including liquidity and idiosyncratic risk are found to be relevant in mutual fund performance evaluation as indicated by significant risk exposures of a set of mutual funds with European investment focus. However, regarding different models the risk-adjusted net performance of these funds is mainly found to be indistinguishable from zero, being in line with equilibrium models of fund performance. Furthermore, the dynamic abilities of fund managers with respect to liquidity and risk factor timing are examined by conducting unconditional as well as time-varying analyses based on a Kalman filter approach. The results reveal dynamics in the risk exposures of mutual funds, but evidence on daily risk factor timing is weak with respect to established risk factors as well as liquidity. Finally, the evidence that both liquidity and idiosyncratic risk affect the cross-section of asset returns suggests that both risk factors capture different return characteristics. As motivated by models of price discovery processes, liquidity might capture transaction costs, while idiosyncratic risk seems to capture effects of price discovery

Mutual Fund Managerial Working Experience, Career Concern, New Fund Opening and Fund Performance

This thesis comprises three essays on mutual fund performance which provide new insights into different aspects of the mutual fund industry. The first essay examines the relationship between the mutual fund manager’s past experience and mutual fund performance. The skills and knowledge acquired from the prior working experience may be transferred to the current working context, thereby influencing the current job performance (Schmidt et al., 1986). Using data on U.S. mutual fund managers’ work experience ranging from 1993 to 2012, we introduce a new method to evaluate mutual fund performance from the perspective of the manager’s lifetime working experience. Specifically, the method involves using the Principal Component Analysis to construct a Managerial Experience Index (MEI) based on 3 professional experience factors from the past career history of each manager: (i) investment objectives of the funds that s/he has managed (Zambrana and Zapatero, 2017), (ii) fund companies that s/he has worked for and (iii) industries of stocks in which s/he has invested (Kacperczyk et al., 2005). The MEI would increase along with the experience accumulation for each mutual fund manager. We group the sample based on the MEI into 5 quintiles from the lowest MEI score (most concentrated experience) to the highest MEI score (most diversified experience). The findings suggest that managers with more specialised experience outperform managers with more diversified experience. In addition, the “Specialist” managers tend to exhibit stock-picking ability while the “Generalist” managers tend to exhibit market-timing ability. The second essay analyzes the performance patterns of new funds during the early stage after their creation, and provides potential explanations for their short-lived outperformance. Using a sample of incubation-free mutual fund data from 1996 to 2015, we address the questions of (i) whether new mutual funds outperform the market and (ii) if they do what may explain their superior performance. We find evidence of out performance for the new funds during their emerging period defined here as the first 6 months of their existence, both before and after fund expenses are taken into account. This outperformance, however, only lasts for a short term and disappears soon after the emerging period. This short-lived outperformance can be explained by the small size effect and IPO stock allocation, but is only weakly associated with managerial characteristics such as team managers and prior experience in equity fund management. Our analysis also provides evidence on a flow-performance relationship. The results suggest that IPO allocation is an effective strategy that enhances investment flows during the emerging period of a new fund. In addition, we find that funds created by team managers attract more flows than funds created by individual managers. The third essay examines if fund managers would take into account turnover risk from a tournament when adjusting the risk of portfolios under their management, where the tournament is defined as the competition in a group with the purpose of being rewarded on their relative performance Conyon et al. (2001). In addition to exploring a statistical correlation between a manager’s discharge from a fund and the realized volatility of the fund that she had been managing, we use an instrumental variable (IV) approach to study whether one may infer causality from such a correlation. Using the instrumental variable (IV) measured as the peer flow pressure in the tournament following the “Rank-of-Ranks” approach in Kempf and Ruenzi (2008), we find that peer flow pressure is a highly statistically significant determinant of manager replacement. Further, the risk of replacement is significantly linked to the fund’s realized idiosyncratic volatility. The finding is robust to the use of an alternative instrumental variable (Segment Flow Rank), an alternative measure of realized risk (Carhart-adjusted Idiosyncratic Risk), and finite distributed lag specifications that incorporate one-period lags of explanatory factors

Two Essays on the Low Volatility Anomaly

I find the low volatility anomaly is present in all but the smallest of stocks. Portfolios can be formed on either total or idiosyncratic volatility to take advantage of this anomaly, but I show measures of idiosyncratic volatility are key. Standard risk-adjusted returns suggest that there is no low volatility anomaly from 1996 through 2011, but I find this result arises from model misspecification. Caution must be taken when analyzing high volatility stocks because their returns have a nonlinear relationship with momentum during market bubbles. I then find that mutual funds with low return volatility in the prior year outperform those with high return volatility by about 5.4% during the next year. After controlling for heterogeneity in fund characteristics, I show that a one standard deviation decrease in fund volatility in the prior year predicts an increase in alpha of about 2.5% in the following year. My evidence suggests that this difference in performance is not due to manager skill but is instead caused by the low volatility anomaly. I find no difference in performance or skill between low and high volatility mutual funds after accounting for the returns on low and high volatility stocks

THREE ESSAYS ON INVESTMENTS

This dissertation consists of three essays on investments. The first essay examines the incidence, determinants, and consequences of hedge fund share restriction changes. This paper finds that nearly one in five hedge funds change their share restrictions (e.g., lockup) over the period of 2007-2012. Share restriction changes are not random. Fund’s asset illiquidity, liquidity risk, and performance are related to share restriction changes. A hazard model indicates that funds who actively manage liquidity concerns live longer by adjusting share restrictions. The paper examines whether changes in share restrictions create an endogeneity bias in the share illiquidity premium (Aragon, 2007) and find that 18% of the premium can be explained by the dynamic nature of contract changes. The second essay examines why mutual funds appear to underperform hedge funds. Utilizing a unique panel of mutual fund contracts changes, this paper explores several possible channels, including: alternative investment practices (e.g., short sales and leverage), performance-based compensation, and the ability to restrict the funding risk of fund flows. This paper documents that over our sample period, mutual funds were more likely to shift their contracting environment closer to that of hedge funds. However, this shift provided no benefit to mutual funds and the paper finds no causal link between these contract changes and improvements in performance. Rather, this paper casts doubt on the binding nature of investment restrictions in the mutual fund industry. The third essay examines whether the 52-week high effect (George and Hwang, 2004) can be explained by risk factors. The paper finds that it is more consistent with investor underreaction caused by anchoring bias: the presumably more sophisticated institutional investors suffer less from this bias and buy (sell) stocks close to (far from) their 52-week highs. Further, the effect is mainly driven by investor underreaction to industry instead of firm-specific information. The 52-week high strategy works best among stocks whose values are more affected by industry factors. The 52-week high strategy based on industry measurement is more profitable than the one based on idiosyncratic measurement

Fund family tournament and performance consequences: evidence from the UK fund industry

By applying tournament analysis to the UK Unit Trusts data, the results support significant risk shifting in the family tournament; i.e. interim winning managers tend to increase their level of risk exposure more than losing managers. It also shows that the risk-adjusted returns of the winners outperform those of the losers following the risk taking, which implies that risk altering can be regarded as an indication of managers’ superior ability. However, the tournament behaviour can still be a costly strategy for investors, since winners can be seen to beat losers in the observed returns due to the deterioration in the performance of their major portfolio holdings

The use of derivatives in the Spanish mutual fund industry

We study the use of derivatives in the Spanish mutual fund industry. The picture that emerges from our analysis is rather negative. In general, the use of derivatives does not improve the performance of the funds. In only one out of eight categories we find some (very weak and not robust) evidence of superior performance. In most of the cases users significantly underperform non users. Furthermore, users do not seem to exhibit superior timing or selectivity skills either, but rather the contrary. This bad performance is only partially explained by the larger fees funds using derivatives charge. Moreover, we do not find evidence of derivatives being used for hedging purposes. We do find evidence of derivatives being used for speculation. But users in only one category exhibit skills as speculators. Finally, we find evidence of derivatives being used to manage the funds’ cash inflows and outflows more efficiently.Mutual Funds, Derivative use, Risk Management