Effect of high-frequency trading on mutual fund performance

Abstract

We find that high-frequency trading (HFT) in stocks held by mutual funds negatively affects fund performance: when sorted by HFT intensity of holdings, funds in the top quintile underperform funds in the bottom quintile by 2.64% per year. The negative relation can be at least partially explained by the illiquidity premium induced by high-frequency traders’ preference for more liquid stocks. This reason for underperformance of mutual funds has not been previously explored or documented. In addition, we do not find evidence to support the concern that HFT raises trading costs of mutual funds.