Mutual Fund Flows and Performance in Rational Markets

Download or read book Mutual Fund Flows and Performance in Rational Markets written by Richard C. Green and published by . This book was released on 2004 with total page 38 pages. Available in PDF, EPUB and Kindle. Book excerpt: We develop a simple rational model of active portfolio management that provides a natural benchmark against which to evaluate observed relationship between returns and fund flows. We show that many effects widely regarded as anomalous are consistent with this simple explanation. In the model, investments with active managers do not outperform passive benchmarks because of the competitive market for capital provision, combined with decreasing returns to scale in active portfolio management. Consequently, past performance cannot be used to predict future returns, or to infer the average skill level of active managers. The lack of persistence in active manager returns does not imply that differential ability across managers is nonexistent or unrewarded, that gathering information about performance is socially wasteful, or that chasing performance is pointless. A strong relationship between past performance and the ow of funds exists in our model, indeed this is the market mechanism that ensures that no predictability in performance exists. Calibrating the model to the fund flows and survivorship rates, we find these features of the data are consistent with the vast majority (80%) of active managers having at least enough skill to make back their fees.