Lottery-like features and mutual fund performance-flow sensitivity

We show that mutual funds' lottery-like features weaken the performance-flow sensitivity, particularly among low-performing funds, thereby contributing to the convexity of the fund performance-flow relation. The results hold when different model specifications are used to test the fund performance-flow relation, are robust to alternative measures for funds' lottery-like features, and cannot be attributed to fund search costs, marketing efforts, or fund performance volatility. Utilizing retail trading data at the account level from a large brokerage firm, we offer additional evidence that funds' lottery-like features significantly reduce outflows for low-performing funds. It confirms that the weakened performance-flow sensitivity among low-performing funds with lottery-like features is driven by existing investors' reluctance to redeem their shares. Furthermore, we reveal that fund managers can cater to investors' gambling preference by tilting fund portfolios toward lottery-type stocks. Funds' lottery-like features, however, aggravate future fund performance, especially among those that have already underperformed in the past.