Mutual Fund Trading Leadership, Herding, and Subsequent Returns
Summary
This article summarizes research on how mutual funds’ trading decisions can lead other funds and how this herding relates to fund returns. It defines buy-leading and sell-leading funds according to whether peers follow their stock purchases or sales in subsequent quarters. The underlying analysis decomposes demand correlations, sorts funds by leadership, compares later risk-adjusted performance, and examines whether trades appear motivated by valuation or liquidity. It also uses regressions that control for fund characteristics.
The study covers U.S. active equity funds from 1980 to 2010. It reports that herding accounts for a substantial share of correlated fund demand, even after considering correlated flows. Buy-leading funds outperform peers over near-term periods, while sell-leading funds underperform; valuation-motivated purchases are associated with stronger results. Evidence on valuation-motivated sales is weaker, potentially because fund managers face limits on short selling. The findings are observational and historical, and the summary offers no guarantee that identifying or following leading funds will work in other periods or markets.
Key ideas
- Fund leadership is measured by how much peers follow a fund’s stock purchases or sales in later quarters.
- The summarized study finds mutual fund herding beyond the effects of correlated fund flows.
- Buy-leading funds show stronger subsequent returns, while sell-leading funds show weaker returns.
- The buy-side relationship is stronger for trades classified as valuation-motivated.
- Short-sale constraints may help explain the limited evidence for valuation-driven selling effects.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.