Starting on the Wrong Foot:Seasonality in Mutual Fund Performance

We document a systematic seasonal component in the aggregate underperformance of active mutual funds. At the aggregate level, active funds underperform the market and other passive benchmarks only in the first month of a quarter. This intra-quarter performance seasonality holds across fund sizes and investment styles. The pattern is consistent with short-term stock return reversal effects along with aggregate window-dressing and, to a lesser extent, NAV-inflation practices around quarter-ends. We find marginal or no evidence of microstructure biases, fund investor flows, or cash distributions as sources of this seasonality. Our findings highlight new features of the active management underperformance puzzle

Riding the Bubble with Convex Incentives

We show that benchmark-linked convex incentives can lead risk-averse money managers aware of mispricing to overinvest in overpriced securities. In the model, the managers’ risk-seeking behavior varies in response to the interaction of mispricing with convexity and benchmarking concerns. Convexity effects can exacerbate the manager’s overinvestment in overvalued nonbenchmark securities. In contrast, they potentially offset the benchmarking effects studied in the literature, leading to underinvestment in overpriced benchmark securities. Under correlated mispricing across assets, our model rationalizes positive positions in nonbenchmark, negative risk premium (i.e., “bubble”) securities and “pairs trading” in two overvalued securities. Our findings help explain several empirical puzzles