Essays on mutual funds

Abstract

This dissertation consists of three essays on mutual funds. The first essay examines the existence of the “smart money effect”. The second essay investigates how the investment horizon contributes to price reaction to analysts’ earnings forecast revision. The third essay explores the liquidity preference of mutual funds and its implication for fund performance. In the first essay, using dataset of monthly actual inflows and outflows, I examine the existence of investors’ fund selection ability, i.e., the smart money effect, in the U.S. mutual fund market. The results show that investors make smart choices when selecting mutual funds. Specifically, they cleverly invest in small funds and cleverly withdraw from large funds. In addition, I show that investors can identify superior funds among top-performing funds as well as inferior funds among loser funds, which means that the smart money effect is distinguished from investors’ return chasing behavior. Overall, I find evidence that investors have fund selection ability in both buying and selling decisions. The second essay investigates how the investment horizon contributes to the stock price reaction associated with analysts forecast revisions. Using a measure for investment horizon of the stocks’ shareholders, STurn, constructed by share-weighted portfolio turnover levels of mutual fund shareholders of the stock, I find that stocks mostly held by short-term horizon investors show stronger and more immediate response during the event-window around forecast revision, while those mostly held by long-term horizon investors exhibit slower and gradual reaction and generate more pronounced post-forecast-revision drifts. The third essay analyzes the liquidity preference of mutual funds and its implications for fund performance. I find that mutual fund managers tilt their holdings more heavily toward liquid stocks during periods of greater likelihood of future redemption. Specifically, they increase highly liquid stock holdings in their portfolios in times that high market volatility, high market illiquidity, and high fund-specific outflow are expected. I also show that precautionary liquidity holding during these periods contributes to abnormal fund performance.