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  5. Mutual Funds and ETFs: Current Issues
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Mutual Funds and ETFs: Current Issues

Paper Session

Monday, Jan. 4, 2021 10:00 AM - 12:00 PM (EST)

Hosted By: American Finance Association
  • Chair: Russell Wermers, University of Maryland

Crowding: Evidence from Fund Managerial Structure

Campbell Harvey
,
Duke University
Yan Liu
,
Purdue University
Eric Tan
,
University of Queensland
Min Zhu
,
University of Queensland

Abstract

Over the past 30 years, there has been a striking evolution in fund management structure with team-managed funds growing from 30% of funds to over 70% today. While much attention is focused on fund performance, our paper presents evidence that this transformation is likely a response to crowding: adding new managers brings fresh investment ideas meaning any particular idea is less likely to be crowded. Our results show that funds that transition from solo to team management have less concentrated portfolios and lower decreasing returns to scale. Consistent with the crowding of ideas, we show that diversification of team skills is important for reducing the impact of fund size on performance. We also find that the performance of managers that employ systematic investment processes are not as sensitive to inflows suggesting that discretionary managers with a limited number of ideas are more likely to run into capacity constraints.

Exchange Traded Funds and Market Runs

Ayan Bhattacharya
,
City University of New York
Maureen O'Hara
,
Cornell University

Abstract

This paper shows how the special structure of exchange traded funds creates the possibility of a market run by enabling a new type of trade where a speculator in one market sells in anticipation that speculators in other markets will sell, further depressing prices and providing a profitable exit. Such trades dominate more conventional strategies when the need for immediacy is high, leading to market runs. Markets facing a run demonstrate many classical features of tumult: large volumes and price swings, sometimes moving prices away from fundamentals. In an extension, we show that the onset of market runs can be very abrupt.

ETF Heartbeat Trades, Tax Efficiencies, and Clienteles: The Role of Taxes in the Flow Migration from Active Mutual Funds to ETFs

Rabih Moussawi
,
Villanova University
Ke Shen
,
Lehigh University
Raisa Velthuis
,
Villanova University

Abstract

We study the use of “heartbeat trades” by ETFs in explaining their superior tax efficiency. By relying on the in-kind-redemption exemption rule, authorized participants help ETFs avoid distributing realized capital gains and reduce their tax overhang. In recent years, ETFs end up with 0.92% lower tax burden per year compared with active mutual funds, partly due to heartbeat trades. Challenged by ETFs’ tax efficiencies, mutual funds exhibit higher flow-tax sensitivity than flow-fee sensitivity. Active mutual funds with relatively higher tax burdens had more outflows from tax-sensitive investors at the same time when ETFs with similar investment styles experienced stronger inflows. Using holdings data of institutions with high net-worth clients, we find that investment advisors with tax-sensitive investors allocate four times more assets to ETFs than other institutions, representing an important driver behind the overall surge in ETF flows, especially after the increase of capital gains tax rate in 2013. We conclude that the migration of flows from active mutual funds to ETFs is driven primarily by tax considerations.

Carrot and Stick: A Risk-Sharing Rationale for Fulcrum Fees in Active Fund Management

Juan Sotes Paladino
,
University of Los Andes
Fernando Zapatero
,
Boston University

Abstract

We show that risk-sharing considerations rationalize symmetric benchmark-adjusted ("fulcrum") fees in the compensation of privately informed active fund management. By tying fees symmetrically to the appropriate benchmark, investors can tilt a fund portfolio toward their optimal risk exposure and realize almost the full value of the manager's information. Since fulcrum fees do not alter the manager's preferred payoff profile, the optimal contract saves the cost of compensating the managers for exposure to undesired risk and attains near-first-best risk sharing. Under certain conditions, fulcrum fees are not only optimal but necessary to avoid a dominance of active management by passive alternatives.
Discussant(s)
Lucian Taylor
,
University of Pennsylvania
Lawrence Schmidt
,
Massachusetts Institute of Technology
Jinming Xue
,
University of Maryland
Ron Kaniel
,
University of Rochester
JEL Classifications
  • G1 - Asset Markets and Pricing