It Ain’t Just What Funds Disclose (It's The Way That They Do It)

Abstract

The finance and accounting literature document how operating company disclosure tone and textual attributes affect firm performance, earnings persistence, stock volatility, capital costs, and retail investor behavior. In this Article, we explore the applicability of these theories to mutual fund disclosure, examining the extent to which disclosure tone influences fund risk and performance. Following (Loughran and McDonald 2011), we first develop customized dictionaries (word lists) specific to mutual fund disclosure language. We also introduce a novel sentiment scoring framework that generates a transparent sentence and disclosure-level score for our sample of 132,000 mutual fund summary prospectuses (497k) from 2010-2018. Our results demonstrate that investment strategy (IS) sections differ in tone and function from principal risk (PR) sections, results that we explore in conjunction with Tucker and Xia (2020) examination of disclosure readability. In particular, we find IS sections are more negative than PR sections—a trend that only increases over time. We also note differences in sentiment scores among CRSP categories, suggesting that asset class drives disclosure tone. A fixed effect regression analysis explores the effect of disclosure tone on fund performance and risk.