Essays on Mutual Funds

Abstract

This thesis consists of two essays on mutual funds.

In the first essay, I propose a new measure, Active Crash Picking (ACP), to identify fund managers with stock-picking ability. ACP assesses fund managers' investment ability conditioned on whether they hold more or less price crash risk-prone stocks in their holdings. For each fund, I examine the covariance between the fund’s portfolio weight in deviation from the market weight and the underlying stock’s price crash risk. Since price crashes destroy the value of investments, ACP can more effectively identify investment ability. Funds in the top decile of high ACP subsequently underperformed their peers in the bottom decile by 4% to 5% per year from 1990 to 2017. Funds in the bottom decile of ACP tend to be smaller in size, active and younger. They attract more new money flows relative to their peers and have higher turnover. They also tend to charge higher fees. Apparently, these patterns of characteristics are market-based reflections of superior managers’ abilities. ACP exhibits strong performance persistence. This finding suggests that investment ability is more evident among mutual fund managers who hold less price crash risk-prone stocks in their portfolios.

The second essay investigates the impact of the business media coverage of fund holdings on risk-shifting in holdings by funds. We capture managers’ ex-ante risk preferences, by using holdings-based risk-shifting measures. We document that the business media decreases both across-year risk-shifting and intra-year risk-shifting activities. More negative news sentiment reduces risk-shifting. The association between the business media and risk-shifting is more robust among managers with high agency issue-motivated risk-shifting incentives, such as managers who have poor past performance, or face a more convex flow-performance relationship or are less experienced. The reduction effect of the media on risk-shifting is more pronounced in bearish markets where employment risk is dominant compared to a bullish market where compensation incentives are dominant. Funds with greater business media coverage also have lower total risk exposure. We address endogeneity concerns using instrumental variable, and the launch of Barron’s online as an exogenous shock. Conclusively, the business media serves as a vital alignment mechanism and has necessary implications for mutual fund managers and investors.

Date of Award	1 Jun 2023
Original language	English
Awarding Institution	City University of Hong Kong
Supervisor	Tao LI (Supervisor)