Speed Of Information Diffusion Within Fund Families
College of William and Mary – Mason School of Business
University of Cologne – Centre for Financial Research (CFR)
University of Cologne – Department of Finance & Centre for Financial Research (CFR)
July 21, 2015
We document that the speed of information dissemination within mutual fund families positively affects the performance of member funds. This suggests that the resulting benefits of higher information precision far outweigh free-riding costs associated with fast internal dissemination. The performance effect intensifies when information travels across managers from different rather than same styles. This is consistent with fast information diffusion aggregating complementary insights that sharpen information precision, but also with fewer free-riding opportunities among managers from different styles. Managers exploit the resulting higher information precision rationally by trading more, relying less on public information, and investing differently from unaffiliated peers.
Speed Of Information Diffusion Within Fund Families – Introduction
Timely dissemination of information within organizations is important. For example, in a typical corporation, it can have a positive effect by increasing efficiency of supply chain management, shortening product development cycles, and improving decision making by senior management in response to changing market conditions. However, quick internal transmission of information could also have a negative effect. By making information readily available, it can provide free-riding incentives for some members of the organization (see, e.g., Cabrera and Cabrera (2002)).1 For example, a division manager might spend less effort developing new production techniques if she is quickly informed of innovations introduced by managers of other divisions. However, despite fast internal dissemination of information potentially affecting organizations in diametrically opposed yet important ways, little is known in the literature of its net effect on the performance of business organizations.
In this paper, we use the mutual fund industry as a testing laboratory to examine how speed of information flows within an organization affects performance. Using the mutual fund industry is attractive for several reasons: First, the dichotomous effects associated with speed of internal information dissemination can be as, or even more, pronounced in this industry. On one hand, the presence of highly efficient financial markets, which quickly impound new information into security prices, make timely internal dissemination of information indispensable to exploiting trading opportunities. On the other hand, fund managers who are quickly informed of the investment ideas of their colleagues will find it easier to free-ride on their colleagues’ efforts. Second, measuring the speed of information dissemination within a fund family is relatively easy because mutual fund managers trade in response to new information, and we are able to observe their trades. Measuring the speed of information flows within a corporation is much more difficult because detailed internal data is typically unavailable. Finally, the mutual fund industry setting allows for a much richer analysis. The reason is that for fund families we can assess the performance effect of the speed of internal information diffusion at the organizational unit level (i.e., fund level) because measuring mutual performance is relatively straightforward. For corporations, this kind of detailed analysis is more challenging since performance data at the organizational unit level is not uniformly available.
Our approach for measuring the speed of information transmission within a fund family is intuitively straightforward. Since information makes investors trade (see, e.g., Milgrom and Stokey (1982)), we can trace the spread of information within a fund family from the trades of affiliated mutual funds. That is, following the introduction of new information on a particular stock to a fund family, the sequence of affiliated fund trades on that same stock should tell us how fast information travels within the fund family. We use this insight to construct our SID (Speed of Information Diffusion) measure. SID is not only computationally attractive because it simply relies on changes in fund holdings but also withstands intuitive validation tests, which show that SID is indeed higher if the family has fewer barriers that impede information flows.
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