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Mutual Fund Flows and Performance in Rational Markets
Abstract
We develop a simple rational model of active portfolio management that provides a natural benchmark against which to evaluate observed relationship between returns and fund flows. We show that many effects widely regarded as anomalous are consistent with this simple explanation. In the model, investments with active managers do not outperform passive benchmarks because of the competitive market for capital provision, combined with decreasing returns to scale in active portfolio management. Consequently, past performance cannot be used to predict future returns, or to infer the average skill level of active managers. The lack of persistence in active manager returns does not imply that differential ability across managers is nonexistent or unrewarded, that gathering information about performance is socially wasteful, or that chasing performance is pointless. A strong relationship between past performance and the ow of funds exists in our model, indeed this is the market mechanism that ensures that no predictability in performance exists. Calibrating the model to the fund flows and survivorship rates, we find these features of the data are consistent with the vast majority (80%) of active managers having at least enough skill to make back their fees.
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“If the market was largely comprised of the investors of Berk and Green (2004) who solely maximized prots, these investors who did not value sustainability would undo the eects of investors with a preference for sustainability, resulting in zero net ows.”
From Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows (2019) · cites this paper as Berk and Green 2004
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In the citing paper
“If a small subset of investors had strong preferences for sustainability while most investors did not directly value sustainability, under standard models (e.g.Berk and Green 2004) we would not nd an eect of the ratings on net ows.”
From Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows (2019) · cites this paper as Berk and Green 2004
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“Berk and Green (2004) assume that funds have decreasing returns to scale which is empirically supported by the ndings of Grinblatt and Titman (1989), Chen et al. (2004), Pástor et al. (2015) (though Reuter and Zitzewitz (2010) do not nd such an eect).”
From Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows (2019) · cites this paper as Berk and Green (2004)
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Citations
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“Indeed, the decreasing returns to scale in active portfolio management is a crucial assumption in an influential rational model proposed by Berk and Green (2004).”
Metadata
- Authors
- Berk, J. B., & Green, R. C.
- Affiliations
- National Bureau of Economic Research (US)
- Carnegie Mellon University (US)
- ORCID
- Berk, Jonathan B.
- Venue
- Journal of Political Economy
- Publisher
- University of Chicago Press
- Published
- 2004-12
- Volume
- 112
- Issue
- 6
- Pages
- 1269-1295
- ISSN
- 0022-3808 (ISSN-L)
- 1537-534X
- OpenAlex
- W3022326679
- Cited by
- 2,083
- References
- 16
- Citations by year
- 2026: 118 · 2025: 123 · 2024: 179 · 2023: 135 · 2022: 128 · 2021: 130 · 2020: 130 · 2019: 105 · 2018: 106 · 2017: 97 · 2016: 83 · 2015: 93 · 2014: 72 · 2013: 92 · 2012: 105
- FWCI
- 54.34
- Type
- journal article
- Language
- en
- Open access
- closed
- Locations
- Journal of Political Economy (publishedVersion)
- RePEc: Research Papers in Economics (submittedVersion)
- Topics
- Social Sciences › Economics, Econometrics and Finance › Finance › Financial Markets and Investment Strategies
- Social Sciences › Economics, Econometrics and Finance › Finance › Corporate Finance and Governance
- Social Sciences › Business, Management and Accounting › Accounting › Financial Analysis and Corporate Governance
- Keywords
- mutual fund flows, fund performance, active portfolio management, rational expectations, performance persistence, active vs passive investing, financial intermediaries, information aggregation
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