Market timing ability of responsible mutual fund investors
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School of Business |
Master's thesis
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Date
2018
Department
Major/Subject
Mcode
Degree programme
Finance
Language
en
Pages
62 + 6
Series
Abstract
Individual mutual fund investors attempt market timing and thus lose to the theoretical return of the fund. Some investor clienteles, however, engage less in short-term market timing and earn higher dollar-weighted returns. These clienteles are associated with high-IQ investors. Socially responsible fund investors incorporate non-financial objectives when making their investment decisions, and, thus, the motivation and behavior of these investors differ from traditional fund investors. Responsible flows are more persistent and more positive, suggesting responsible investors have longer investment horizons. This gives reason to suspect responsible investors engage less in market timing and as a result earn better dollar-weighted returns. This indicates responsible investors could be a high-IQ clientele. I explore this market timing ability of responsible fund investors by studying the performance gaps for responsible and traditional fund investors. I exploit the large amount of US equity mutual fund data available, include funds from 1990 to 2016 and use propensity score matching to create comparable samples of responsible and traditional fund investors. I then utilize a novel method for decomposing the performance gap and isolating the timing component to bring new insight into the literature regarding responsible investor timing ability. At first, my results contradict the hypothesis of responsible investors as a high-IQ clientele as I find higher performance gaps for responsible investors compared to investors in traditional funds. When using the simple performance gap, responsible investors annually suffer from timing underperformance 0.7 percentage points more than traditional investors. The responsibility is also positively correlated with the performance gap for years when fund investors on average have lost due to timing. This result holds even after controlling for years. However, when decomposing the simple performance gap and only looking at the timing component, responsible investors do not differ from traditional investors in their timing underperformance and both lose equally to the buy-and-hold return of the fund. The difference between responsible investors’ simple performance gap and their timing performance gap arises from the return distribution of responsible funds. In addition, I find that the simple performance gap is a highly year dependent measure and that no clear convergence in the performance gaps of responsible fund investors and traditional fund investors can be observed. As well as employing a novel method for a comprehensive dataset, the study proposes new avenues for future research regarding index fund investor timing ability and the effect of return distributions to performance gap.Description
Thesis advisor
Kaustia, MarkkuKeywords
responsible investors, mutual funds, performance gap, timing, smart investors