Diane Del Guercio and Paula A. Tkac
Working Paper 2000-21
November 2000

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Due to differences in financial sophistication and agency relationships, we posit that investors use different criteria to select portfolio managers in the retail mutual fund and fiduciary pension fund industry segments. We provide evidence on investors’ manager selection criteria by estimating the relation between manager asset flow and performance. We find that pension fund clients use quantitatively sophisticated measures like Jensen’s alpha, tracking error, and outperformance of a market benchmark. Pension clients also punish poorly performing managers by withdrawing assets under management. In contrast, mutual fund investors use raw return performance and flock disproportionately to recent winners but do not withdraw assets from recent losers. Mutual fund manager flow is significantly positively related to Jensen’s alpha, a seemingly anomalous result in light of a relatively unsophisticated mutual fund client base. We provide preliminary evidence, however, that this relation is driven by a high correlation between Jensen’s alpha and widely available summary performance measures, such as Morningstar’s star rating. By documenting differences in the flow-performance relation, we contribute to the growing literature linking fund manager behavior to the implicit incentives to increase assets under management. We show that several forces combine to weaken the incentive for pension fund managers to engage in the type of risk-shifting behavior identified in the mutual fund literature.

JEL classification: G2, G1, L1

Key words: mutual funds, pension funds, fund flows, performance evaluation

The authors gratefully acknowledge research support from the Oregon Joint Professional Schools of Business Program. They also thank an anonymous referee, Carl Ackermann, John Chalmers, Larry Dann, Wayne Ferson, Laura Field, Aditya Kaul, Mark LaPlante, Kai Li, Tim Loughran, Wayne Mikkelson, Megan Partch, Jim Peterson, Roberta Romano, Paul Schultz, Katherine Spiess, Laura Starks, Rene Stulz, and seminar participants at the Oregon Research Roundup, Oregon State University, Pacific Northwest Finance Conference, Portland Society of Chartered Financial Analysts, Securities and Exchange Commission, Tenth Annual Finance and Accounting Conference (Austin, Texas, 1999), University of Alberta, University of California Riverside, University of Notre Dame, and the 1998 Western Finance Association meetings (Monterey, California) for helpful suggestions. The authors also benefited from conversations with Wes Wilson. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to Diane Del Guercio, Lundquist College of Business, University of Oregon, Eugene, Oregon 97403-1208, 541-346-5179, dianedg@oregon.uoregon.edu, or Paula A. Tkac, Research Department, Federal Reserve Bank of Atlanta, 104 Marietta Street, N.W., Atlanta, GA 30303-2713, 404-498-8813, paula.tkac@atl.frb.org.