‘Whom Do You Trust?’ Investor-Advisor Relationships And Mutual Fund Flows
Carroll School of Management, Boston College
March 31, 2013
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I measure the value that investors place on trust and relationships in asset management by examining mutual fund flows around announced changes in the ownership of fund management companies. I find a decline in flows of around 7% of fund assets in the year following the announcement date, starting after announcement and accelerating after the closing date of the ownership change. A decomposition into inflows and outflows shows that the overall decrease in flows is entirely driven by increasing outflows with no change in inflows. Retail investors and investors in funds with higher expense ratios are most responsive to ownership changes, providing new evidence that such investors place a significant value on trust and are more likely to respond to a relationship disruption by withdrawing their assets. Alternative explanations such as changes in distribution network, reactions to expected fund closure, expected or past manager changes, or poor expected returns do not seem to explain the results.
‘Whom Do You Trust?’ Investor-Advisor Relationships And Mutual Fund Flows – Introduction
An important unanswered question in the field of delegated asset management is how much importance investors place on who is managing their money. Asset management companies spend more than a billion dollars each year on advertising (Gallagher, Kaniel, and Starks, 2006), much of it trying to persuade investors that their firm will provide them with trustworthy and dependable financial advice (Mullainathan, Schwartzstein, and Shleifer, 2008). Gennaioli, Shleifer, and Vishny (2012) propose that the well-documented empirical finding that average active mutual fund alphas are negative (e.g., Jensen, 1968) is due to a “trust” premium, which allows asset management firms to charge investors additional fees if there is a trusting relationship between them. They write that trust can be established through “personal relationships, familiarity, persuasive advertising, connections to friends and colleagues, communication, and schmoozing,” all of which are likely to be disrupted by an exogenous change in firm management.
In this paper, I measure the value of trustworthy relationships between investors and asset management firms by examining mutual fund flows around management company ownership changes. My main finding is that mutual fund flows turn negative in response to announced changes in the parent company or ownership of a fund’s advisor. A reduction in flows begins after the announcement date and is initially about 3% of assets (on an annualized basis), and then accelerates after the closing date to total approximately 7% of assets over the twelve months following the announcement date. The results are robust to controlling for fund characteristics such as the past five years of returns, age, fund and family size, and style, as well as parent company characteristics (for public parent companies) such as the parent’s market capitalization and past year’s stock returns.
An alternative empirical strategy would be to look at flows around individual manager changes. The main problem with that strategy is that manager changes are highly correlated with past fund performance (Chevalier and Ellison, 1999) and fund flows are also extremely sensitive to past performance (Sirri and Tufano, 1998), making it difficult to disentangle performance-driven outflows from outflows due to manager changes. In addition, there is a reverse causality problem if managers can anticipate future flows and voluntarily depart the fund when they expect fund outflows, and therefore reductions in assets under management and their own compensation.
My empirical strategy begins with an examination of 185 events (covering 843 funds) from 1995 through 2011, where there is a change in the ownership of the fund’s management company (mergers and acquisitions involving the management company itself or its parent). One example of such a merger occurred in 2001 when Deutsche Bank announced its purchase of Zurich Scudder, the manager of the Scudder Funds, from Zurich Financial. In order to control for parent company characteristics, I next restrict the sample to the 78 events (covering 391 funds) involving ownership changes of U.S. public parent companies. While management company ownership changes are less likely to be driven by a particular fund’s performance than manager changes, it is still possible that they are related to the entire management company’s past investment performance. In order to rule out such endogeneity concerns, I perform a more rigorous test, restricting the event space to the 70 events (covering 295 funds) in which the public parent company undergoing an ownership change derives a small share of revenues (<10%) from its mutual fund operations, and find similar results.
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