Is your fund watching out for you?

Abstract

We examine the relationship between the performance of mutual funds and their effectiveness in correcting underperforming funds and safeguarding shareholder interests. In this paper, we investigate whether boards and advisors prioritize for shareholder interests. Our objective is to understand whether actively managed equity funds that do not beat their benchmarks take any action, measured in a variety of ways, to correct poor performance. On average, less than one-third of actively managed equity mutual funds beat their benchmarks, and 61 % of equity funds have lagged the Standard & Poor's 500 Index over the past ten years. Our results suggest that most mutual funds take actions to reverse their fund performance, up to 63 %. Removing the fund manager is the most common action taken to reverse performance. However, we do find that the majority of funds still perform poorly two and three years later. In particular, we find that 67 % of funds present negative alphas two years after an action and 70 % of funds underperform three years afterward. Finally, we show that the performance flow relation suggests that fund actions are preceded by lower asset flows, thus limiting the investment advisory fees charged by funds in the pre-action years.