Working Paper: NBER ID: w16312
Authors: Diane Del Guercio; Jonathan Reuter; Paula A. Tkac
Abstract: We study the impact of investor heterogeneity on mutual fund market segmentation. To motivate our empirical analysis, we make two assumptions. First, some investors inherently value broker services. Second, because brokers are only compensated when they sell mutual funds, they have little incentive to recommend funds available at lower cost elsewhere. The need for mutual fund families to internalize broker incentives leads us to predict that the market for mutual funds will be highly segmented, with families targeting either do-it-yourself investors or investors who value broker services, but not both. Using novel distribution channel data, we find strong empirical support for this prediction; only 3.3% of families serve both market segments. We also predict and find strong evidence that mutual funds targeting performance-sensitive, do-it-yourself investors will invest more in portfolio management. Our findings have important implications for the expected relation between mutual fund fees and returns, tests of fund manager ability, and the puzzle of active management. Furthermore, they suggest that changing the way investors compensate brokers will change the nature of competition in the mutual fund industry.
Keywords: mutual funds; market segmentation; broker incentives
JEL Codes: G14; G23; L1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investor heterogeneity (G11) | mutual fund market segmentation (G23) |
| Broker incentives (G24) | mutual fund market segmentation (G23) |
| Mutual fund families targeting performance-sensitive do-it-yourself investors (G23) | invest more in portfolio management (G11) |
| invest more in portfolio management (G11) | higher before-fee returns (G19) |
| Mutual funds in the direct channel (G23) | higher risk-adjusted returns (G11) |
| Changes in broker compensation structures (G24) | alter competitive dynamics in the mutual fund industry (G34) |