Fund Flows, Momentum, and Mutual Fund Performance

Abstract

Past research has questioned the intelligence of mutual fund investors, where intelligence is defined as the future performance of new cash flows into mutual funds. New mutual fund dollars tend to overwhelmingly flow toward those funds that have recently outperformed their peers. This fact, along with the momentum effect, or persistence in performance, would tentatively suggest that funds that have performed well against their peers should continue to do so. This article explores the impact of recent historical performance and fund flows, both independently and jointly, on the performance of domestic equity mutual funds. The author finds that across large-cap, mid-cap, and small-cap mutual fund capitalization groups, the cost associated with fund flows, based on a market neutral flow factor, is -46 basis points (bps), -121 bps, and -152 bps, respectively. The results of this analysis suggest there are significant costs associated with domestic equity mutual fund flows that should be considered during the mutual fund purchase and retention decision-making process.