Working Paper: NBER ID: w30234
Authors: Winston Wei Dou; Leonid Kogan; Wei Wu
Abstract: Active equity funds care about fund size, affected by fund flows that obey a strong factor structure with the common component responding to macroeconomic shocks. Funds hedge against common flows by tilting their portfolios toward low-flow-beta stocks, while household/retail and index investors overweight high-flow-beta stocks in equilibrium. Consequently, common flows earn a risk premium, leading to a multi-factor asset-pricing model resembling the ICAPM, even with myopic agents and unsophisticated fund clients. Exploiting quasi-experiments induced by the local-natural-disaster occurrences and the unexpected trade-war announcements, we find that an increased outflow risk faced by funds leads to more aggressive flow-hedging portfolio tilts.
Keywords: fund flows; asset pricing; active equity funds; flow hedging
JEL Codes: G11; G12; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| common fund flows (G23) | compensated risk factor (D91) |
| common fund flows (G23) | asset allocation decisions (G11) |
| active equity funds hedge against common flow shocks (G23) | portfolio tilt toward low-flow-beta stocks (G11) |
| high-flow-beta stocks (G12) | significantly higher excess returns (G12) |
| high-flow-beta stocks (G12) | significantly higher CAPM alphas (G19) |
| household-retail investors overweight high-flow-beta stocks (G41) | benefit from elevated risk premia (G19) |
| common fund flows (G23) | negatively correlated with macroeconomic uncertainty (D89) |
| increased outflow risk (F65) | funds hedge more aggressively (G23) |
| funds hedge more aggressively (G23) | tilt toward low-flow-beta stocks (G12) |
| tilt toward low-flow-beta stocks (G12) | negatively impact fund performance (G23) |