Partial adjustment towards performance‐based mutual fund returns: Evidence from U.S.‐based equity funds

• Published in: International journal of finance and economics 2021-10, Vol.26 (4), p.5864-5883
• Main Authors: Hippler, William J., Hassan, M. Kabir, Pezzo, Luca
• Format: Article
• Language: English
• Subjects: active portfolio management; Equity funds; mutual fund performance and efficiency; Mutual funds; partial adjustment models; Portfolio management
• ISSN: 1076-9307; 1099-1158
• DOI: 10.1002/ijfe.2098

Mutual fund managers face heavy competition and have incentives to quickly re‐allocate their portfolios in order to achieve and beat their performance targets. However, portfolio adjustments are costly, as trading, administrative, and information costs reduce net returns. Therefore, managers face a trade‐off between the benefits of adjusting the portfolio in order to achieve/exceed performance targets and the costs associated with these adjustments. We apply an asymmetric partial adjustment model to a sample of U.S.‐based, open‐ended, equity mutual funds. Our results show that active mutual funds quickly offset and reverse underperformance and have some success in maintaining short‐term, above‐average fund performance. The average mutual fund in our sample offsets 103% of the deviation within 1 month following underperformance, while slowing adjustment to 84% of the deviation following outperformance. Moreover, we link relative performance‐driven portfolio rebalancing to heterogeneous information costs across fund investment objectives and find that funds focusing on acquiring more specific and costly information adjust more efficiently than those with broader investment objectives.