Expecting your fund manager to help you limit losses if the market turns downward? The odds are against you, according to a new study.
The study, titled “Is There an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets? Fund Performance and Subsequent Annual Fund Flows between 1997 and 2011,” was performed by researchers from Pace University and Touro College. It found that “there is an incentive for active managers to closet-index in down markets, as investors do not reward outperformance [in down markets] with higher flows,” according to Investment News.
“If you outperform everyone, you’re still not going to get inflows,” explained Matthew Morey, a New York Stock Exchange research scholar and finance professor at Pace. “Let’s say you’re down 10%, but everybody else is down 20%. People aren’t going to be giving you assets like they would if you were up 20% and everybody else is up 10%.”
Without the incentive of more inflows to their funds — which usually determines how much money they make — many fund managers can put less effort into beating their benchmark index during down markets, and instead come closer to following the index, Morey said. The result can be index-like performance at active-fund management prices.
During up years for the market, investors do reward fund managers who outperform. “There are widely disparate reactions to winning and losing,” Morey said. “Not only do losses hurt us more than gains perk us up, but we have this predisposition to want to get back to even.”