THREE ESSAYS ON MUTUAL FUNDS

Saurin Patel
Desautels Faculty of Management,
McGill University,
Montreal, Quebec, Canada

June 2013

A thesis submitted to McGill University in partial fulfillment of the

requirements for the degree of Doctor of Philosophy

Copyright 2013 by Saurin Patel. All rights reserved.

DEDICATION

To my beloved family.

ACKNOWLEDGEMENTS
I have many individuals to thank for their help during the course of my doctoral
studies. First and foremost, I want to thank my co-supervisors, Professors Sergei
Sarkissian and Susan Christoffersen, for their guidance, support, and mentoring over the
years. I appreciate all their contributions of time, ideas, and funding to make my doctoral
experience productive and stimulating. Their comments and feedback on the chapters of
this thesis were extremely helpful and showed me the path to become a better researcher.
Without both of them, I would not be where I am academically.
I thank my dissertation committee members, George Aragon, Laurent Barras,
Martin Boyer, Dr. John Burgess, Abhirup Chakrabarti, and Jean-Claude Cosset for
agreeing to be a part of my committee and allocating their time to providing valuable
feedback.
I am very grateful to the administrative staff in the Ph.D. office for their constant
support. In particular, I want to thank Stella Scalia, Susan Lovasik, and Karen Robertson
for their thoughtfulness and eagerness to help. A special thanks to Pierre Cambron for his
invaluable help in keeping my computers running smoothly.
I would also like to express my gratitude to Professor Saibal Ray, Ph.D. Program
director, for his constant encouragement and support throughout my doctoral studies.
I gratefully acknowledge the financial support from McGill University, Fond
Qubcois de Recherche sur la Socit et Culture (FQRSC), Walter John Stenason Ph.D.
Fellowship and National Bank Financial Group Ph.D. Fellowship. Without their
generous financial support, it would have been impossible for me to complete my
doctoral studies.
I want to thank my fellow doctoral students, many of whom have become very
close friends for life. Especially Burcin Col, Paul Intrevado, Rajasekhar Kakumani,
Mehdi Karoui, Xuhui (Nick) Pan, and Russell Seidle, who have taught me a great deal
about finance and more importantly about academic life. I have thoroughly enjoyed their
camaraderie and will never forget the quality time I have spent with them.
3

Last but not least, I want to thank my family for all their unconditional love and
constant encouragement. Without them, none of this would be possible. Especially my
parents, Kusum and Pramod Patel, who have taught me the true meaning of life and have
always encouraged me to take on difficult challenges in life including pursuing a doctoral
degree. My sisters, Urvashi and Jignya, who have always believed in me and showed me
the right path in life. Finally, my loving wife, Pinal, whose unceasing support during the
final stages of my doctoral studies helped me complete this dissertation.

ABSTRACT
This dissertation consists of three essays. The first essay examines whether investors'
optimism about the future economic growth affects their future investment decisions.
Drawing from the insights of the theoretical literature on investment behavior, we argue
that investors base their future investment decisions not only on asset-specific
information and existing macroeconomic environment, but also on their beliefs about
future economic growth. Consistent with this premise, we find that investors' investment
decisions, measured by mutual fund flows, are positively influenced by their economic
optimism, even after controlling for various fund characteristics and macroeconomic
conditions. Moreover, this effect is more pronounced for funds with greater fund-specific
information uncertainty, i.e. funds that are small, belong to smaller fund families, or have
highly volatile past performance. Our results suggest that investors not only consider
forward-looking economic optimism in their investment decisions, but also put greater
weight on it when fund-specific information seems uninformative and less valuable.
The second essay examines the impact of group decision making on fund performance,
their risk-taking behavior and other fund characteristics using a large U.S. equity mutual
fund database. The literature has conflicting reports regarding the impact of team based
managerial structure on fund performance. We first observe that in mutual fund studies
this results from large discrepancies in reported managerial structures between CRSP and
Morningstar databases reaching on average 20% per year. Then we show that with more
superior Morningstar data team-managed funds exhibit higher risk-adjusted returns than
single-managed funds. The performance spread is present across all fund categories,
except aggressive funds, and is robust to the inclusion of fund- and manager-level
controls. Across various managerial structures, the largest team-induced gains are
reached among funds managed by three individuals. Furthermore, teams significantly
improve fund performance when funds are located in financial centers, reflecting larger
networking potential and/or better skills of people who reside in larger cities. This
improvement is achieved in teams more homogeneous in age and education. In spite of
higher returns however, team-managed funds are not riskier than single-managed funds
in terms of market exposure or idiosyncratic volatility. Finally, team-managed funds
trade less aggressively and are able to generate extra inflows for their funds. Thus,
collective decision making is beneficial, but its scale depends on team size and diversity
as well as its geographic location.
The third essay examines the relation between managerial structure and the likelihood of
deception. Using U.S. equity mutual fund data, we find that team-managed funds deceive
significantly less than single-managed funds. In particular, we show that two trading
activities portfolio pumping and window dressing, which are considered illegal or
quasi-illegal, are more profound or exists at all only among single-managed funds. We
also document a negative relation between the extent of those two activities and team
size. Subsequent tests indicate that these results are not driven by various fund
characteristics that differ between single- and team-managed funds, such as fund returns,
size, and turnover. In addition, we observe that portfolio pumping is present most
strongly among the worst performing single-managed funds, while window dressing
5

occurs primarily again among single-managed funds but in the middle performance
group for which it has the largest potential benefits. Overall, our findings support the
notion that team is a desirable form of organization as it helps weaken incentives to
deceive.

RSUM
Cette thse se compose de trois essais. Le premier essai examine si loptimisme des
investisseurs concernant la croissance conomique future affecte leurs dcisions
dinvestissement futures. En sappuyant sur les connaissances de la littrature thorique
sur le comportement des investisseurs, nous pensons que les investisseurs fondent leurs
dcisions dinvestissement futures non seulement sur linformation spcifique aux actifs
et lenvironnement macro-conomique, mais aussi sur leurs croyances au sujet de la
croissance conomique future. En accord avec cette hypothse, nous trouvons que les
dcisions dinvestissement, mesure par les flux de fonds communs de placement, sont
positivement influences par loptimisme conomique des investisseurs, mme aprs
avoir contrl pour les caractristiques diverses des fonds et les conditions
macroconomiques. De plus, cet effet est plus prononc pour les fonds avec une
incertitude plus grande de linformation propre au fonds, cest--dire les fonds qui sont
petites, qui appartiennent des familles de fonds plus petits, ou qui ont des performances
passes trs volatiles. Nos rsultats suggrent non seulement que les investisseurs
tiennent compte des noncs conomiques prospectifs de caractre optimiste dans leurs
dcisions dinvestissement, mais quils mettent aussi plus de poids sur ces noncs quand
linformation spcifique au fonds semble peu informative et moins valable.
Le deuxime essai examine limpact de la prise de dcision collective sur le rendement
du fonds, leur comportement en termes de prise de risque et autres caractristiques de
fonds, en utilisant un grand base de donnes traitant des fonds communs de placement
amricains. La littrature dmontre des rapports contradictoires concernant limpact de la
structure de gestion dquipe sur le rendement des fonds. Nous observons tout dabord
que dans les tudes de fonds communs de placement ce rsultat dcoule des grandes
diffrences dans les structures de gestion rapports entre les bases de donnes CRSP et
Morningstar, qui atteignant en moyenne 20 pourcent par an. Ensuite, nous montrons
quavec les donnes suprieures de Morningstar les fonds grs par des quipes
prsentent des rendements ajusts au risque plus levs que celles des fonds grs par les
individus. Lcart de performance est prsent travers toutes les catgories de fonds,
lexception des fonds agressifs, et est robuste linclusion des contrles au niveau du
fonds et du gestionnaire. travers diverses structures de gestion, les plus grandes gains
induites par les quipes sont atteints par les fonds grs par trois individus. Par ailleurs,
les quipes amliorent considrablement le rendement du fonds lorsque les fonds sont
situs dans des centres financiers, refltant le plus grand potentiel de rseautage et / ou
les meilleures comptences des personnes qui habitent dans les grandes villes. Cette
amlioration est obtenue au sein dquipes plus homognes en termes dge et de
lducation. En dpit des rendements plus levs, toutefois, les fonds grs par des
quipes ne sont pas plus risqus que les fonds grs par un seul individu en termes
dexposition au march ou la volatilit idiosyncrasique. Enfin, les fonds grs par des
quipes schangent de faon moins agressive et sont capables de gnrer des entres
supplmentaires pour leurs fonds. Ainsi, la prise de dcision collective est bnfique,
mais son ampleur dpend de la taille de lquipe et de la diversit ainsi que de sa
situation gographique.

Le troisime essai examine la relation entre la structure de gestion et le risque de

tromperie. En utilisant les donnes sur les actifs de fonds communs de placement
amricains, nous constatons que les fonds grs par des quipes trompent beaucoup
moins que ceux grs par les individus. En particulier, nous montrons que deux activits
portfolio pumping et window dressing qui sont considres comme illgales ou
quasi-clandestines, sont plus profondes ou existent seulement parmi les fonds grs par
les individus. Nous avons galement document une relation ngative entre lampleur de
ces deux activits et la taille de lquipe. Des tests ultrieurs indiquent que ces rsultats
ne sont pas motivs par diverses caractristiques des fonds qui diffrent entre les fonds
grs par individus et quipes, tels que le rendement des fonds, la taille, et le chiffre
daffaires. En outre, nous observons que le portfolio pumping est prsent le plus
fortement parmi les fonds moins performants grs par les individus, tandis que le
window dressing se produit principalement chez les fonds grs par les individus, mais
dans le groupe de performance moyenne pour lequel il prsente les plus grands avantages
possibles. Dans l'ensemble, nos rsultats soutiennent lide que lquipe est une forme
dorganisation souhaitable car elle contribue affaiblir les incitations tromper.

Table of Contents
Dedication....................................................................................................................................... 2
Acknowledgements ........................................................................................................................ 3
Abstract .......................................................................................................................................... 5
Rsum ........................................................................................................................................... 7
Contribution of Authors ............................................................................................................. 11
Chapter 1 ...................................................................................................................................... 12
Introduction
Chapter 2 ...................................................................................................................................... 18
Economic Optimism, Information Uncertainty and Future Investment Decisions:
Evidence of the Mutual Fund Industry
2.1 Introduction ...................................................................................................................................................19
2.2 Hypotheses Development ..............................................................................................................................23
2.3 Data ...............................................................................................................................................................29
2.3.1
Investor Expectations ...........................................................................................................................29
2.3.2
Mutual Fund Sample ............................................................................................................................33
2.3.4
Macroeconomic Control Variables ......................................................................................................37
2.4 Empirical Analysis ........................................................................................................................................38
2.4.1
Influence of Investor Expectations on Future Fund Flows ..................................................................38
2.4.2
Role of Information Uncertainty in Fund Purchase Decisions .............................................................42
2.5 Summary and Conclusion..............................................................................................................................49
Appendix .................................................................................................................................................................51
Figure ......................................................................................................................................................................54

Chapter 3 ...................................................................................................................................... 65
To Group or Not to Group? Evidence from Mutual Funds
3.1 Introduction ...................................................................................................................................................66
3.2 Motivation and Hypotheses Development.....................................................................................................71
3.3 Data ...............................................................................................................................................................74
3.3.1
Main Data Source ................................................................................................................................74
3.3.2
Fund Characteristics.............................................................................................................................75
3.3.3
Fund Manager Characteristics .............................................................................................................76
3.3.4
Fund Performance Measures ................................................................................................................78
3.3.5
Summary Statistics...............................................................................................................................80
3.4 Management Structure: CRSP versus Morningstar .......................................................................................82
3.4.1
Fund Management Structure Differences ............................................................................................82
3.4.2
Fund Performance Differences ............................................................................................................85
3.4.3
Additional Misspecification Issues in Management Structure .............................................................88
3.5 Team Management and Fund Performance: Empirical Tests ........................................................................89
3.5.1
The Average Effect of Team Management ..........................................................................................89
3.5.2
The Effect of an Additional Team Member .........................................................................................92
3.5.3
Team Management and Geographic Location .....................................................................................94
3.5.4
The Role of Team Diversity................................................................................................................96
3.6 Team Management, Risk Taking, and Fund Characteristics .........................................................................99
3.7 Conclusions .................................................................................................................................................102
Table .....................................................................................................................................................................104
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Chapter 4 ................................................................................................................................... 119

Deception and Managerial Structure: A Joint Study of Portfolio Pumping and
Window Dressing Practices
4.1 Introduction ................................................................................................................................................. 120
4.2 Motivation and Related Literature............................................................................................................... 125
4.3 Portfolio Pumping and Managerial Structure .............................................................................................. 129
4.3.1
The Detail of Portfolio Pumping Phenomenon and its Estimation Methodology .............................. 129
4.3.2
Test Results ........................................................................................................................................ 133
4.4 Window Dressing and Managerial Structure............................................................................................... 138
4.4.1
The Details of Window Dressing Phenomenon and its Estimation Methodology ............................. 138
4.4.2
Test Results ........................................................................................................................................ 142
4.4.3
The Dot-com Bubble: A Special Case of Window Dressing ............................................................. 148
4.5 Conclusions ................................................................................................................................................. 149
Appendix............................................................................................................................................................... 151
Table ..................................................................................................................................................................... 154

Chapter 5 ................................................................................................................................... 168

Conclusions
Bibliography .............................................................................................................................. 173

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CONTRIBUTION OF AUTHORS
The second chapter of this thesis titled, "Economic Optimism, Information
Uncertainty and Future Investment Decisions: Evidence from the Mutual Fund Industry",
is my work and I am solely responsible for this chapter.
The third and fourth chapters of this thesis titled, "To Group or Not to Group?
Evidence from Mutual Funds", and, "Deception and Managerial Structure: A Joint Study
of Portfolio Pumping and Window Dressing Practices", respectively, are in joint
collaboration with Sergei Sarkissian. Currently, Sergei is an Associate Professor of
Finance at Desautels Faculty of Management, McGill University. We have contributed
equally to both these chapters.

11

Chapter 1
Introduction

12

Over the past several decades, the U.S. mutual fund industry has experienced
tremendous growth. Right from $135 billion in total assets under management at the end
of 1980 to $13 trillion in assets at the end of 2011. One of the main drivers behind this
remarkable growth is the increased use of mutual funds as a preferred investment vehicle
by individual households in United States. According to 2012 Investment Company
Institute (ICI) Fact book, an estimated 52.3 million households, or 44 percent of all U.S.
households, owned mutual funds in 2011 compared to only 4.6 percent in 1980. The
surge in the U.S. mutual fund industry size along with the increased participation of
individual households provides a unique opportunity to study investment behavior of
individual households. In particular, what type of information is relevant to households
and how they make their mutual fund investment decisions?
Understanding these questions is at the heart of chapter two. Economic theory
argues investors base their investment decisions broadly on three types of information.
First, the asset-specific information such as past dividends, valuation ratios and other
characteristics that signals the intrinsic value of an asset. Second, the information related
to the current economic conditions that reflects the existing investment opportunities.
And third, investors' expectations about the future economic environment which might
affect the future returns of an asset. While much of previous literature, especially in
mutual funds, focuses on fund- and economy-specific information to explain mutual fund
flows, a proxy for investors' investment decisions. Little attention is given to whether
expectations affect investment decisions and if so, how expectations enter the investment
decision-making process. Addressing these questions is the main objective of chapter
two. Building on the theoretical insight, we empirically test if expectations about future
economic growth can influence investors' investment decisions, in addition to other well
known information variables. We start by constructing a new and robust measure of
investor expectations (INVEXP) which accurately captures individual investors'
13

expectations about what will happen to the economy as a whole in the future. Unlike
existing proxies, our measure offers three distinct advantages: i) it is a direct and cleaner
measure, ii) it is highly correlated to well known state variables, and iii) it has desirable
statistical properties such as relative stability, stationarity and persistence. We then
investigate whether INVEXP affects individual mutual fund flows, a proxy of investor's
investment decisions. We find that INVEXP positively influences mutual fund flows.
This result shows that expectations are important to investors and investors increase their
allocation to riskier equity fund when they are optimistic about the future. Then, we
focus on how expectations enter the investment decision-making process. To test this we
follow the economic theory which suggests investors trade-off different pieces of
information in making their investment decisions based on the quality or precision of
information.1 We find that mutual fund flows are more sensitive to expectations for funds
that have noisy and poor quality of fund-specific information, such as funds with highly
volatile past performance, funds that belong to smaller fund families and smaller sized
funds. Overall, our results strongly indicate the positive influence of investors' economic
expectations on their investment decisions and show that investors put greater weight on
their economic expectations in making investment decisions whenever the fund-specific
information is noisy and less informative.
Another important yet understudied trend in the U.S. mutual fund industry is the
rise of team-managed funds. In 1992, approximately 30 percent all domestic diversified
equity mutual funds were managed by teams of portfolio managers whereas 70 percent
managed by single portfolio managers. Compare that to 2010, when approximately 70
percent of all equity funds were managed by teams and only 30 percent by single
managers. This sudden rise in team-based managerial structure raises an important
question: Why are mutual fund families moving towards team-based management?
1

See e.g. Grossman and Stiglitz (1980).

14

Chapter three investigates the rise of team-based management structures from the
perspective of fund performance. Theoretical studies, such as Sharpe (1981) and Barry
and Stark (1984), argue that teams are beneficial in the portfolio management industry
because they improve fund performance by achieving higher degree of specialization,
diversification of opinions and reducing portfolio risk. But several empirical studies find
that team-managed funds perform poorly compared to single-manager funds.2 This
evidence is puzzling because it is in direct conflict with theory and industry trend. In
chapter three, we examine this puzzle in the light of new data. Using a relatively new
data from MorningStar, we find that there exists a positive relation between teams and
fund performance, consistent with the theory and industry trend. Further, we show that
the negative relation documented by previous empirical studies is because of large
misspecification in CRSP managerial data. We find that CRSP database inaccurately
reports the number of portfolio managers responsible for day to day activities of a fund.
This misspecification ranges between as low as 10 percent to as high as 26 percent of
entire sample per year. The second part of this chapter analyzes whether number of teammembers, location of teams and diversity among team-members affects the team-fund
performance relation. No empirical mutual fund study to-date, to the best of our
knowledge, analyzes these conditional effects. We show that there exists a non-linear
relation between team size and fund performance. In particular, we find that threemember teams tend to generate highest fund performance relative to single-manager
funds. We also show that location of teams plays a very important role in teams'
performance. We find the benefits of team management are strongly present among
funds located in financial centers but not among those located in non-financial centers.
We also show that diversity among team-members, especially in age and educational
backgrounds, can hurt team performance. In other words, funds with more homogeneous
2

See e.g. Chen, Hong, Huang and Kubik (2004), Kempf and Ruenzi (2005) and Han, Noe and Rebello
(2008).
15

team members in terms of age and educational background outperform those with more
heterogeneous managers. Overall, our results point to the benefits of team-based
managerial structures in terms of fund performance which might help explain the rise of
teams within the mutual fund industry.
Chapter four investigates the relation between team-based managerial structure
and the likelihood of engaging in unethical or illegal conduct. Discouraging people from
engaging in unethical or illegal behavior remains a big challenge for social sciences
especially economics. The economic literature points to two reasons which encourage
agents to engage in unethical behavior: i) over-incentivization within contracts (see e.g.
Jacobs and Levitt (2003)) and ii) imperfect monitoring (see e.g. Holmstrom (1979)). But
at the same time, several theoretical studies argue that "team production" can address
both these reasons by reducing the "over-incentivization" problem and increasing
monitoring through peer monitoring.3 We test this theoretical assertion empirically in this
chapter. In particular, we test if team-based managerial structures deter agents from
engaging in deceptive and unethical behavior. We achieve this goal by examining the
extent of portfolio pumping and window dressing -- the two fund trading practices that
are considered illegal and quasi-illegal respectively -- among single- and team-managed
funds in the U.S. mutual fund industry. Consistent with prior theoretical studies, we show
that single-managed funds involve in these deceptive trading practices significantly more
than team-managed funds. In particular, we find that team-managed funds involve
significantly less in portfolio pumping and do not involve in window dressing at all.
Moreover, we also document a negative relation between the extent of these two
dishonest trading activities and team size. Overall, our results show that team-based
managerial structure can significantly inhibits managers' drive to engage in dishonest

See Arnott & Stiglitz (1991), Kandel & Lazear (1992) and Acemoglu, Kremer and Main (2008).
16

trading practices which can be beneficial to both individual investors and industry as a
whole.

17

Chapter 2
Economic Optimism, Information
Uncertainty and
Future Investment Decisions:
Evidence from the Mutual Fund Industry

18

"The task of security analysis consists in rearranging the data descriptive of the state of
the economy, of the states and trends of the industries of specific firms, and of firms
themselves, [...] in the light of the bases on which investors individually may judge
prospects. Whatever tools of analysis an investor uses, [...] the only appropriate basis on
which to found expectations and judgments is the composite set of environmental and
financial facts available at the time of choice."
Smith (1971)

2.1

Introduction
Making investment decisions is a complex task. It involves gathering and

analyzing a large amount of information in order to make an informed choice. But little is
known about the precise nature of information that investors gather and how they analyze
this information in their minds? In this paper, we broadly examine the different types of
information investors gather and how this information enters their investment decision.
Investors care about information that helps them assess the future value of an
investment. Intuitively, this information can be broadly divided into three types. First, the
asset-specific information such as past dividends, valuation ratios and other
characteristics that signals the intrinsic value of an asset. Second, the information related
to the current economic conditions that reflects the existing investment opportunities.
And third, the anticipation or optimism about future economic environment which might
affect the future returns of an asset. Financial theory acknowledges this intuition and
describes investors' information set as a function of observable asset-specific
information, current state of economy, and expected economic and political environment
(e.g., Smith (1971), Veronesi (2000)). Particularly, emphasizing the importance of
investors' economic expectations or beliefs in investment decisions (see e.g., Shackle
(1942), Angell (1960), Smith (1971) and Veronesi (2000)). However, the empirical
literature focuses only on asset-specific and current economic information to explain

19

investor decisions and pays little attention to the role of investors' economic optimism.4
While few studies recognize that flows into mutual funds capture investors' optimism and
sentiment, the literature does not separate the part of funds flows arising from optimism
compared to asset-specific and current macroeconomic information.5
This leads us to our first research question. Does optimism about future economic
growth play an important role in investors' investment decision-making in addition to
asset-specific and current economic information? The next question that arises is - how
do investors combine these three types of information to arrive at a final decision?
Financial theory argues that investors combine different pieces of information based on
the quality of the information (see e.g., Grossman and Stiglitz (1980), Veronesi (2000)
and Epstein and Schneider (2008)). That is, investors put less weight on the information
that has relatively lower quality, and more weight on relatively higher quality
information. For instance, in situations when investors are uncertain about investing in an
asset based on its noisy asset-specific information, they tend to rely more on other pieces
of information in their information set to make an investment decision. Similarly, when
investors are absolutely certain about the value of asset based on high-quality assetspecific information, they pay less attention to other information in their information set.
Following this insight, we test the following research question: Do investors tradeoff
between different types of information based on information quality when making
investment decision?

See e.g., Ippolito (1992), Hendricks, Patel and Zeckhauser (1993), Chevalier and Ellison (1997), Sirri and
Tufano (1998), Grinblatt and Keloharju (2000) and Barber, Odean and Zheng (2005) among others show
the influence of asset-specific information of investor decisions; Malmendier and Nagel (2011) show
influence of stock market's past performance on individual investors decisions; Warther (1995), Aber and
Santini (1998), Cao, Chang and Wang (2008) and Chalmers, Kaul and Phillips (2011) show the influence
of current economic conditions on aggregate investment decisions.

See Ben-Rephael, Kandel and Wohl (2011) for references.

20

To test both these questions empirically, we use the mutual fund industry data in
the United States along with a novel measure of investors' economic optimism. Mutual
fund industry is one of the best places to study investment behavior because one can with
relative ease and clarity infer the investment decisions of investors through flows into
and out of individual mutual funds (see Ippolito (1992), Sirri and Tufano (1998)). In
addition, the data on mutual fund flows goes back enough in time that researchers are
able to study investor behavior over a significantly longer time periods. And it is
relatively straightforward to define and control asset-specific information in a mutual
fund setting using different fund characteristics such as fund performance and fund fees.
To capture investors' optimism about future economic growth, we use the survey
data from the University of Michigan Survey Research Center (henceforth UMSRC).
Every month UMSRC surveys individual households on their expectations about future
economic conditions in the U.S. including business conditions (including future stock
market growth, GDP growth, etc.), inflation, unemployment, interest rates as well as
their personal financial situation. Using the survey responses that focus solely on
economic expectations, we construct a new expectations index (INVEXP). Using
quarterly mutual fund data from 1970 to 2008, we find that investors' investment
decisions, proxied by fund flows, respond positively to optimism about future economic
conditions even after controlling for fund-specific and current economic information.
That is, one standard deviation increase in investors' optimism increases fund flows into
an average equity fund by 4% (or $12 million) per year in addition to fund-specific and
current economic conditions.6 This result clearly shows the importance of investors'
economic optimism in their investment decisions and validates the theoretical insight
provided in the literature.

Compared to $118 million of new money inflows per year in an average sized fund in our sample.
21

To test whether investors tradeoff different pieces of information in making

investment decision, we find that when fund-specific information is noisy and of poorquality, investors rely more on their economic optimism in making their investment
decisions. That is, flows into funds with noisy fund-specific information are more
sensitive to economic optimism than funds with relative more precise fund-specific
information. Using different fund characteristics as proxies for high fund-specific
information uncertainty, we find that flows into funds with highly volatile past
performance, funds that belong to smaller fund families and smaller sized funds receive
additional inflows ($9 - $19 million per year) when investors are optimistic about future
economic conditions. These results clearly show that investors not only consider their
economic optimism in making investment decisions, but also put greater weight on it
whenever the asset-specific information is noisy or less precise.
Our paper makes three contributions to the literature. First, it offers novel
approach to understanding investors' investment decisions based on three different types
of information: asset-specific, current economic conditions, and expectations about
future economic conditions. Unlike previous studies, we examine the role of investors'
economic optimism in investors' investment decisions in the presence of asset-specific
information and current economic conditions. We find robust evidence of positive and
significant relation between investors' economic optimism and their future investment
decisions. That is, investors not only consider forward-looking economic information in
addition to asset-specific and existing economic information before making their
investment decisions, but also increase (decrease) their wealth allocation into risky assets
when they are optimistic (pessimistic) about the future.
Second, we offer new empirical evidence on how investors combine different
types of information when making investment decisions. Consistent with theoretical
literature, we find that investors tradeoff different types of information based on the
22

quality of information. In particular, we find that investors put greater weight on their
economic optimism in making investment decisions when the fund-specific information
is noisy and less informative.
Finally, we develop a new and robust measure of investor expectations
(INVEXP) that captures investors' optimism/pessimism about future economic
conditions. Unlike the existing expectations proxies, this proxy offers three distinct
advantages: (i) it is a direct and cleaner measure of investor expectations, (ii) it is highly
correlated with known state variables which predict future economic conditions, and (iii)
it has desirable statistical properties such as relative stability, stationarity and lines up
accurately with known periods of investor optimism and pessimism.
The rest of this paper is organized as follows. Section II discusses the related
literature and hypotheses development. Section III describes, in detail, the construct and
validation of the investor expectations proxy along with the mutual fund data. Section IV
covers the empirical test design that investigates the link between investor expectations
and mutual fund flows and presents empirical evidence as to why this link may exist.
Section V summarizes and concludes.

2.2

Hypotheses Development
Several theoretical studies in finance recognize the importance of expectations or

optimism in investors' investment decision-making process. Studies as early as Shackle

(1942) point out that economic theory places too much emphasis on investors'
preferences and too little on their feelings of hope, doubt or fear. Shackle argues that
investors base their investment decisions on the notion of "potential surprise" which is
the degree of surprise beyond investors' initial expectations. Angell (1960), in line with

23

Shackle (1942), argues that may prevail during the life of the investment in their
investment decisions. In doing so, investors judge the "prospect" for success of a
particular investment security under these various alternatives. Smith (1971) argues that
in order to make informed investment choice, investors not only need some knowledge
about the different characteristics of investment security, but also need to know the state
and trend of a nation's economy, as well as the conditions in the money and securities
markets. More recent studies such as Veronesi (2000) and Kacperczyk, Van
Nieuwerburgh and Veldkamp (2011) formalize the role of expectations in investment
decisions using standard general equilibrium framework and model investors' posterior
distribution as a function of investors' expectations about future economic growth and
asset-specific information.
Despite such strong theoretical arguments in favor of investor optimism, the
empirical literature overlooks investor optimism and focuses only on asset-specific and
existing macroeconomic information in explaining their investment decisions. For
instance, a large body of empirical literature in mutual funds shows that investors'
decisions to buy and sell mutual funds is influenced by fund-specific information such
as fund's past performance (see e.g., Ippolito (1992), Hendricks, Patel and Zeckhauser
(1993), Sirri and Tufano (1998)); fund fees (see Sirri and Tufano (1998) and Barber,
Odean and Zhang (2005)); and other non-performance characteristics such as fund
advertisements expenses (see Capon, Fitzsimons and Prince (1996); Jain and Wu
(2000)). Research from non-mutual fund setting also shows that individual household's
decisions to buy and sell individual stocks is influence by historical stock returns
(Grinblatt and Keloharju (2000)). Similarly, another strand of empirical literature shows
that investors' investment decisions, in aggregate, are influenced by existing financial and
economic conditions such as stock market returns (Warther (1995)); stock market
volatility (Cao, Chang and Wang (2008)); and changes in aggregate economic conditions
24

such as short-term interest rates, personal disposable income, default spreads and term
spreads (Aber and Santini (1998), Chalmers, Kaul and Phillips (2011)).
The absence of any empirical investigation into the importance of investors'
economic optimism in their investment behavior motivates this paper. The first research
question that we ask is: Does investors' optimism about future economic growth affect
their investment decisions? Intuitively, investors, at least in aggregate, alter the riskiness
of their portfolios in response to expected changes in economic conditions. In other
words, when investors are optimistic about the future, they are willing to undertake more
risk by investing in relatively riskier equity funds. Thus, we should expect a positive
relation between investor optimism and subsequent mutual fund flows. This intuition
leads us to our first hypothesis:
Hypothesis 1: Investor expectations about future economic conditions are
positively associated with mutual fund flows in subsequent periods.
The second question that we raise is: how do investors combine the different types of
information in their minds to arrive at an actual investment decision? Do investors
simply aggregate all pieces of information or weigh different information based on some
criteria? Intuition suggests that given investors' limited capacity to process a large variety
of information simultaneously, weighing different types of information based on its
quality, reliability or likelihood of occurrence seems more likely choice. Economic
theory seems to support this intuition. For example, Grossman and Stiglitz (1980) argue
that investors' demand for a risky asset varies with the quality of information that
investors have in their information set. In particular, the higher the quality or precision of
information, the greater the weight that information in investors' information set and
hence the greater the demand for that asset. Veronesi (2000) rationalizes investors'
information set as a precision-weighted function of past dividend realizations and

25

expectations about future economic growth and argues that information quality affects
equity premium. More recently, Epstein and Schneider (2008) use Bayesian setting to
study the effect of uncertain information quality on asset prices and model investors'
posterior distribution as a function mean dividend payoff, future aggregate economic
conditions and idiosyncratic shock to the asset. All in all, these studies point to one thing:
investors tradeoff high quality information for low quality information in making
investment decisions. In particular, investors put less weight on the information that has
relatively lower quality, and more weight on relatively higher quality information. In our
setting, this implies that when investors are uncertain about the fund quality based on
noisy fund-specific information, they tend to rely more on other pieces of information in
their information set. That is, when there is high information uncertainty related to fundspecific information, economic optimism plays a greater role in investors' investment
decisions by making investors less risk averse. A direct way to test this argument is to
see if the flows into funds with high information uncertainty are more sensitive to
investors' optimism than flows into funds with low information uncertainty. This
motivates our second hypothesis:
Hypothesis 2: The sensitivity of mutual fund flows to investor expectations is
greater for funds with higher fund-specific information uncertainty.
Following Hirshleifer (2001) and Zhang (2006), we formally define information
uncertainty as the ambiguity in assessing the quality of a fund based on noisy fundspecific signals. The imprecision or noisiness in fund-specific signals stems from two
sources: volatility of a fund's underlying fundamental value and poor quality fund
information.7 We use different fund characteristics as proxies for funds' underlying
7

In standard theoretical literature, an observed signal (s) is viewed as a fund's fundamental value (f), such
as fund manager's ability to generate returns in excess of a benchmark measured by risk-adjusted fund
performance, plus some noise, that is, si = fi + ei. The information uncertainty is measured by the variance
or noisiness in the observed signal, var(si) = var(fi) + var(ei), where var(fi) reflects volatility of fund i's
underlying fundamentals and var(ei) reflects quality of fund-specific information.
26

fundamentals as well as quality of information and develop two testable empirical

predictions.
Our first empirical prediction deals with volatility in a fund's fundamental value
measured by volatility in managerial skill. Mutual fund investors value a fund based on
the fund manager's ability to generate returns in excess of a benchmark. Thus, the most
important determinant of a fund's fundamental value is managerial skill. We define
managerial skill as the ability of the fund manager to generate fund returns in excess of
passive as well as non-passive benchmarks (Pastor and Stambaugh (2002)). Empirically,
we measure managerial skill by monthly risk-adjusted fund performance. Any
uncertainty in ascertaining managerial skill affects investors' perception about the future
value of the fund. Using the standard deviation of monthly risk-adjusted fund
performance over the past year as a proxy for managerial skill uncertainty (Pastor and
Stambaugh (2002)), we argue that investors perceive funds with high fund performance
volatility as ones with greater managerial skill uncertainty.8 Thus, the uncertainty mainly
arises from the volatility in fund's underlying fundamental value. At the same time,
economic optimism about the future economy lessens investor's risk aversion towards
these perceived risky funds. And as a result, they underweight fund-specific information
for funds with greater managerial skill uncertainty and overweight their economic
expectations when making future fund purchase decisions in these funds. Formally put,
our first empirical prediction is:
Prediction 1: The sensitivity of fund flows to investor expectations is greater for
funds with higher managerial skill uncertainty.
8

Consistent with the Bayesian approach, investors form their posterior expectations about managerial skill
by combining their initial prior and the signal embedded in the historical fund performance. Now, if the
skill signal is precise and unambiguous (corresponds to low volatility in historical fund performance), then
the investors infer superior managerial skill, but in cases where the signal is noisy (corresponds to high
volatility in historical fund performance), it is more likely that investors infer the lack of superior stockpicking skill in the fund manager.
27

Our second empirical prediction relates to the second source of imprecision: poor
quality fund information. To measure the quality of fund-specific information, we use
two fund characteristics as proxies: size of the fund family and size of the fund. We use
fund family size, measured by the total net assets under management of a fund family
each quarter, to proxy for information uncertainty due to poor information. Following
Sirri and Tufano (1998), we argue that smaller fund families are more likely to have
higher fund information uncertainty because they tend to have poor visibility and lower
brand awareness compared to larger families as well as high information disclosure costs.
In addition, the number of fund analyst and amount of media coverage for smaller fund
families is also quite low. As a result, potential mutual fund investors face higher search
costs and may find it difficult to evaluate fund quality based solely on fund- specific
information. Based on this, we predict that when investors face a dilemma when
choosing to invest in funds that belong to small and lesser known fund families, they put
more weight on their economic expectations compared to historical fund-specific signals.
Our second proxy for poor fund-specific information is fund size, measured by
total assets under management each quarter. We argue that investors perceive fund
information related to the quality of small funds with greater uncertainty. This is largely
due to three possible reasons: (i) extreme difficulty in differentiating themselves from
other existing mutual funds due to smaller advertising budgets, (ii) lack of credible or
verifiable historical information and (iii) possible lack of genuine skill. In addition, small
funds are highly risky investment partly due to unlimited growth opportunities with an
equally high probability of disappearance, as noted by Brown (1995). Whichever the
reason, we argue that investors are extremely reluctant to base their investment decisions
in small funds solely on fund-specific information. As a result of this reluctance,
investors rely on their expectations about future economic conditions in addition to fund-

28

specific information to make subsequent fund purchase decisions. Combining fund and
family size proxies, we formally state our second hypothesis:
Prediction 2: The sensitivity of fund flows to investor expectations is greater for
funds that belong to smaller fund families and funds that are smaller in size.

2.3

Data

2.3.1

Investor Expectations
To investigate whether investors' optimism affects their future mutual fund

investment decisions, we need a robust empirical measure that explicitly captures

investors' expectations about future economic growth. To this end, we construct a new
index of investor expectations from the survey data of the University of Michigan Survey
Research Center (UMSRC) from 1970 to 2008. Prior to 1978, the UMSRC data was
available at a quarterly frequency at 2, 5, 8, and 11 months, but from the beginning of
1978, the data is available at monthly frequency. For our purposes, we are interested in
the quarterly data and so we convert the monthly data after 1978 in a quarterly frequency
by including observations corresponding to 3, 6, 9, and 12 months.
Each month the UMSRC telephonically interviews a representative sample of
approximately 500 individual households across the United States and asks over 50 core
questions broadly related to their personal financial situation, their expectations about
future economic conditions in the United States economy, and their propensity to
consume major household items. Of these 50 questions, we focus on the five questions
that relate to households' expectations about future economic conditions in the U.S.
economy including changes in their personal financial situation, changes in business
conditions, unemployment situation, general price levels and changes in the interest rates

29

over the next 12 months. Specifically, the five questions as they appear in the UMSRC
questionnaire are:
A3. "Now looking ahead -- do you think that a year from now you (and your
family living there) will be better off financially, or worse off, or just about the
same as now?"
A7. "And how about a year from now, do you expect that in the country as a
whole business conditions will be better, or worse than they are at present, or
just about the same?"
A10. "How about people out of work during the coming 12 months -- do you
think that there will be more unemployment than now, about the same, or less?"
A11. "No one can say for sure, but what do you think will happen to interest
rates for borrowing money during the next 12 months -- will they go up, stay the
same, or go down?"
A12. "During the next 12 months, do you think that prices in general will go up,
or go down, or stay where they are now?" and "By about what percent do you
expect prices to go up, on the average, during the next 12 months?"

The relative score for each question is then calculated as the percentage of favorable
minus the percentage of unfavorable responses, plus 100, rounded to the nearest whole
number (See Appendix B for details).
Using these relative scores, we form a composite investor expectations index that
captures individual investors' overall economic outlook for next the 12 months which
includes both their future personal financial well-being and future macroeconomic
conditions. We start by aggregating the relative scores of the five survey questions in
each quarter over the entire sample and dividing it by the sum of the relative values of
30

the first quarter of the base year (1985).9 The choice of base year is motivated by the fact
that 1985 is neither a peak nor trough of a business cycle. The resulting index is defined
as the investor expectations index (INVEXP). Figure 1 shows the evolution of INVEXP
through historical business cycle peaks and troughs.
Panel A in Table 1 summarizes INVEXP along with each of its component
survey questions. We find that over the entire sample, the mean value of INVEXP index
is around 90, while the standard deviation is 11.03. We also find that the autocorrelation
coefficient declines exponentially from 0.79 in the first lag to 0.39 in the fourth lag. This
clearly indicates persistence in investors' economic expectations over time. This
persistence is a desirable property because it signals that investors carefully build their
economic expectations over an extended period of time and not as a knee-jerk reaction to
short-term favorable or unfavorable economic news such as one day stock market
crashes. Along with summary statistics, we also report the Augmented Dicky-Fuller
(ADF) test (with a constant and 4 lags) of stationarity for levels of INVEXP and its
components. The ADF test statistic for INVEXP is -4.01 (with the critical value of -3.49
at 1%) and clearly rejects the null hypothesis of non-stationarity. Thus, we use levels in
the predictive regression framework. In addition, Figure 2 plots the relative scores of
each component and the index levels of INVEXP and the NBER recession periods over
time.
A natural question that arises is whether INVEXP is a valid proxy of investor
expectations. Under ideal circumstances, a valid investor expectations proxy should
exhibit three important characteristics: (i) be a representative direct survey response of
investors, (ii) be highly correlated with future economic conditions, and (iii) reflect
information that other well-established economic expectations proxies capture. Given
9

For robustness purposes, we try different base years and also try the equally-weighted average of the
relative scores of all the questions. Our results remain unchanged.
31

that INVEXP is constructed from the direct survey responses of a representative sample
of individual households in the U.S., it satisfies the first characteristic by construction.
To test whether INVEXP is highly correlated with future economic conditions, we
analyze the pair-wise correlation coefficient of INVEXP with different state variables
which are well-known in the literature to predict future economic conditions. The first
row in Panel B of Table 1 reports contemporaneous correlation coefficients, while the
second row reports correlations between INVEXP at time t-1 and state variables at time t.
Focusing on the first row, we find that INVEXP has the highest (positive and statistically
significant) correlation of 0.50 with future term spread, a strong indicator of short-term
business cycles (see Fama and French (1989), Chen (1991)).
Similarly, we find that INVEXP is correlated with changes in short-term interest
rates (-0.20), growth in industrial production (0.23) and stock market returns (0.18).
Given this evidence, we conclude with some degree of confidence that INVEXP captures
with future economic conditions with expected signs and satisfies the second
characteristic.10 Now, we turn to the third characteristic -- the empirical validation of
INVEXP index. To validate INVEXP, we use the Conference Board Expectations Index
(CBEXP) as a reasonable alternative proxy which captures similar information but from
different respondents and is well recognized in practice. The most important validation
test is the correlation between INVEXP and CBEXP. If both these proxies capture
similar information, then they should be positively correlated to each other. We find that

10

Several papers confirm our results in a more formal econometric framework. See e.g., Carroll (2003)
who shows that the consumer expectations survey data (from UMSRC) on future inflation and
unemployment rate have highly statistically significant predictive power for the changes in future inflation
and unemployment rate even after controlling for the lagged inflation and unemployment rate; Bram and
Ludvigson (1998) and Ludvigson (2004) who show that consumer confidence surveys have strong
predictive power for quarterly consumer expenditure growth. More recently, Lemmon and Portniaguina
(2006) show that the consumer expectations survey data (from the University of Michigan) does
particularly a good job of predicting future economic activity, especially in the post-1977 period.
32

INVEXP is highly positively correlated (0.42) with CBEXP, which indicates that the two
proxies share a strong common component.
But if CBEXP captures similar information, the question is why not use it as a
proxy for investor expectations instead? The answer lies in several important differences
between the two proxies. First, INVEXP is based on survey responses to five questions
covering personal financial situation, business conditions, inflation, interest rates and
unemployment. CBEXP, in comparison, is based on three questions that are limited to
business conditions, unemployment and total family income. Second, the survey
questions in INVEXP focus on the economic conditions in the country as a whole, while
CBEXP questions focus on the economic conditions in the respondent's area of
residence. And lastly, INVEXP measures expectations over a longer term (12 months)
compared to CBEXP which measures expectations over a shorter term (six months).
Third, INVEXP correlates highly with TERM (0.50) and dSIR (-0.20) which are strong
indicators of future economic conditions, whereas CBEXP has statistically zero
correlation with TERM and has a opposite sign with dSIR (0.32). Thus, keeping these
important differences in mind, INVEXP seems a more suitable measure for our analysis
than CBEXP. Nonetheless, for robustness purposes, we reexamine some of our results
using CBEXP and report them in Tables 4 and 6.
2.3.2 Mutual Fund Sample
Our mutual fund data are from the Center for Research in Security Prices (CRSP)
Survivorship Bias Free Database. The data includes quarterly information related to
funds' total net assets (TNAs), returns (net of expenses), operating expenses, front-end
loads, inception date and fund management of all open-end equity funds offered to
investors from January 1970 through December 2008. Consistent with prior mutual fund
studies, we primarily focus on domestic equity funds which broadly include aggressive

33

growth, growth, growth and income, value and long-term growth funds.11 We exclude
sector, international and balanced funds from our analysis. In addition, we treat different
share classes of the same fund as separate funds due to difference in their fund flows,
loads and fees structures. To minimize the impact of fund size and age on our results, we
only focus on funds that have an average TNA of greater than 10 million dollars annually
and are in existence for more than one year. Based on these data filters, our sample
covers 12,562 unique fund-entities over 156 quarters spanning the first quarter of 1970 to
the last quarter of 2008. Table 2 describes the cross-sectional characteristics of our
mutual fund dataset over the entire sample period and over four subsamples: the decades
of 1970, 1980, 1990 and 2000.
The primary reason behind the choice of this particular time period and crosssection is to provide a unique and perhaps the most comprehensive setting to test and
analyze the influence of investors' economic expectations on their mutual fund
investment decisions. The length of the sample period from 1970 to 2008 maximizes the
coverage of periods with relatively high economic optimism and pessimism, including
the era of Reagan optimism (late 1970s to mid 1980s), the Technology bubble (late
1990s), the housing market bubble (early 2000s) and the recent period of economic
pessimism after the financial crisis (mid 2007 on- wards). Similarly, the cross-sectional
coverage of our mutual fund data closely resembles the actual investment opportunity set
that individual investors face in the real world. Hence, these characteristics ensure that
our results provide a more realistic assessment of investors' investment decisions.

11

We include domestic equity funds that meet the following investment objective classifications: Policy
code: CS, Hedge, TFE, MF, Pfd; the Wiesenberger code: G, G-I, G-I-S, G-S, G-S-I, I, S-G, I-S, I-S-G, I-GS, S-I-G, S-G-I, I-G, S-I, GCI, SCG, LTG, MCG, IEQ; the Strategic Insight code: AGG, GMC, GRI, GRO,
ING, SCG; and the Lipper Code: CA, DL DSB, EI, EIEI, ELCC, EMN, G, GI, LCCE, LCGE, LCVE,
LSE, MC, MCCE, MCGE, MCVE, MLCE, MLGE, MLVE, MR, SCCE, SCGE, SCVE, SESE, SG, SP,
SPSP. In case, a particular fund has more than one objective code in a particular year, we choose the
objective code with greater granularity.
34

To capture the unobservable investment decisions of investors, we use observable

mutual fund flows as a proxy. We define net fund flows (FLOWS) as net growth in the
total net assets of funds, as a percentage of their total net assets, adjusted for prior period
returns. FLOWS are also adjusted for any increase in total net assets due to mergers.
Formally, it is defined as
, =

 ,  , ,  ,

 ,

(1)

where TNAi,t is the total net assets of fund i, Ri,t is the return net of expenses, MGTNAi,t
is the increase in the total net assets of fund i due to merger. Since the exact timing of the
cash flows is unknown, we assume that new money flows in and out of each fund at the
end of each quarter. We also assume that all dividends and distributions are reinvested in
the fund at the end of each quarter. FLOWS reflect how investors select different funds
to allocate their wealth based on their anticipation of future performance and economic
conditions. The first row in Table 2 reports the averages of the cross-sectional means and
standard deviations of FLOWS, measured at the end of each quarter. We find that, on
average, the equity funds have enjoyed relatively higher quarterly inflow of 18.22% in
the 1990s compared to the 1970s when the mutual fund industry was in its infancy.
Interestingly, even the cross-sectional dispersion of fund flows increased from 13.71% in
1970s to 63.25% in 2000s along with the size (both in terms of assets under management
and number of funds) of the mutual fund industry.
Now, we focus on the fund-specific characteristics that we need to control for and
will be used as independent variables in our analysis. These characteristics are well
known in the literature to be salient to fund investors and to affect individual mutual fund
flows. These typically include fund's historical performance, size, age, size of fund
family and total expenses.

35

First, we measure the fund's historical performance by the relative rank of the
fund's raw return (net of expenses) in each quarter. Each fund is assigned a relative rank
ranging from zero (worst performer) to one (best performer) each quarter. This
performance measure is in the spirit of Sirri and Tufano (1998) among others, who
documented that investors are "performance-chasers" and are highly sensitive to fund's
historical performance.
Second, fund size and fund age are defined as the total net assets under fund's
management at the end of quarter t and the difference between the fund's inception date
and the current quarter t, in years, respectively. The third and fourth rows in Table 2
describe the evolution of fund size and age over the last three decades. With the increase
in the size of the mutual fund industry, the average fund size increased almost four-fold
from $134 million in the 1970s to $495 million in the 2000s. Similarly, as the number of
funds offered to investors increased, the average fund age decreased from 12.4 years in
the 1970s to 7.32 years in the 2000s.
Third, we measure the size of the fund family as the sum of the total net assets
under management of all funds belonging to the same fund family in quarter t. We find
that the average size of a fund family over the entire sample is $13 billion. The average
fund family size increases from $12 billion in the 1980s to almost $43 billion in the
2000s.
Consistent with Sirri and Tufano (1998) and Barber, Odean and Zheng (2005)
who document the negative impact of total expenses on individual mutual fund flows, we
define total fund expenses as the expense ratio plus the up-front load amortized over a
seven-year holding period.12 The last row in Table 2 reports the annualized total expenses
over the last three decades. We find that the average total expenses across funds have
12

Because the expense data is available on an annual basis, we match the annual expense data with
quarterly frequency without adjusting for the frequency change.
36

been monotonically decreasing from 1.82% in the 1970s to 1.44% in the 1990s and
finally to 1.32% in the 2000s.
In contrast, the average cross-sectional dispersion among funds' total expenses
has increased from 0.67% in 1970s to 0.87% in 2000s. We also consider the volatility of
funds' returns, measured by standard deviation of raw returns of funds over the past year,
as a fund-specific control variable. But the lack of strong and consistent empirical
evidence for the influence of fund return volatility over future fund flows discourages us
from using it as a control variable.13 Nonetheless for robustness, we control for fund
return volatility in our regression specifications, and in unreported results, find that our
findings remain robust. To minimize the influence of extreme observations on our
results, we winsorize fund flows, fund size and fund family data at the 1 % and 99%
levels.
2.3.4

Macroeconomic Control Variables

One might argue that individual investors' future fund purchase decisions are

primarily based on the most recent performance of equity mutual funds, which might be
influenced by prevailing macroeconomic conditions. To address this argument, we
control for the current macroeconomic conditions using two sets of factors: financial and
real-economy. The economic data are collected from CRSP, DataStream and the Federal
Reserve (FRED) databases for the period from 1970 to 2008 on a quarterly basis.
Following Chen (1991), the real economy factors include changes in Industrial
Production (dIndProd), changes in Real Personal Disposable Income (dRPDI), change in
Real Personal Consumption Expenditures (dRPCE) and changes in Unemployment Rate
(dUNEMR). The financial factors include default spread (DEF), term spread (TERM),

13

For example, Sirri and Tufano (1998) find no evidence of fund's raw return volatility influencing
subsequent period fund flows. In contrast, Barber, Odean and Zheng (2005) find some evidence of fund
return volatility being important to future fund flows.
37

stock market return (SMRET) and changes in short-term interest rates (dSIR).
Consistent with previous studies, the default spread is defined as the difference
between the bond yields of Moody's Aaa- and Baa-rated corporate bonds, while the term
spread is the difference between the bond yields of 10 year long-term government bond
and the three-month Treasury bill. The stock market return is the value-weighted return
(including dividends) of the NYSE/AMEX/NASDAQ stock indexes on a quarterly basis.
The short-term interest rates are defined as the market rate on three-month Treasury bill
at the end of each quarter.

2.4

Empirical Analysis
In this section, we empirically test our research hypotheses stated in section II

using a panel regression framework, pooled over thirty-nine years. In subsection A, we

analyze whether investor expectations about future economic growth influences future
fund flows in the presence of different fund characteristics and existing macroeconomic
conditions. And in subsection B, we test the role of fund-specific information uncertainty
as a plausible explanation for why investor expectations might be influence future fund
flows.
2.4.1 Influence of Investor Expectations on Future Fund Flows
Given our discussion in the hypotheses development section, we expect to find a
positive relationship between investor expectations and future fund flows. To test this,
we estimate the following panel regression equation:
FLOWSi,t = a + bINVEXPt-1 + c1Perfi,t-1 + c2FundAgei,t-1 + c3FundSizei,t-1
+ c4TotalFeesi,t-1 + c5FamilySizei,t-1 + dCategoryFlowst-1 + Controlst-1 + ei,t,
(2)

38

where FLOWSi,t is the percentage growth in the assets of fund i over quarter t, INVEXPt1

is the investor expectations measure for quarter t-1, Perfi,t-1 is the relative rank of fund

i's raw return at time t-1, FundAgei,t-1 is the number of years since fund inception at time
t-1, FundSizei,t-1 is natural logarithm of fund i's total net assets at time t-1, TotalFeesi,t-1 is
the total fund fees (operating expenses plus one-seventh of front end load fees) at time t1, FamilySize i,t-1 is natural logarithm of total net assets under fund i's family at time t-1,
CategoryFlowst-1 is the net growth in total net assets of all funds that belong a particular
Strategic Insights investment objective category at t-1.14 Controlst-1 is the vector of
macroeconomic controls which includes financial and real economy variables at time t-1.
Financial variables include default spreads (Default), term spreads (TERM), valueweighted CRSP stock market returns (SMRET), and changes in short-term (dSIR)
interest rates. Real-economy variables include log growth rates in industrial production
(dIndProd), real personal consumption expenditure (dRPCE), real personal disposable
income (dRPDI) and unemployment rate (dUNEMP). The error term in the regression is
denoted by ei,t. To address any concerns regarding potentially correlated errors within
fund and time dimension (e.g., Petersen (2009) and Thompson (2011)), we estimate the
standard errors by clustering at the fund and time dimensions. The coefficient of interest
is b from the regression equation (2). It captures the sensitivity of subsequent fund flows
to level of INVEXP. Based on our discussions in section II, we expect, ex ante, this
coefficient estimate to be positive and statistically significant. That is, when investors are
optimistic about the future economy, equity mutual funds receive higher inflows in the
subsequent period, in addition to flows due to important individual fund characteristics
such as past performance as well as existing macroeconomic conditions.

14

The Strategic Insights investment objective categories include Aggressive Growth (AGG), Growth and
Income (GRI), Growth (GRO), Income and Growth (ING), Mid-caps (GMC) and Small-caps (SCG).
39

The results presented in Table 3 strongly support our first hypothesis. As

predicted, we find a positive and statistically significant relationship between investor
expectations and subsequent fund flows across different regression specifications.
Column (A) presents the results of the regression specification with investor expectations
as the sole explanatory variable. We find a positive and statistically significant b
coefficient estimate. For example, a one-standard deviation increase in investor
expectations increases subsequent fund flows by 7.06% (0.0016*11.03*4) per year. That
is, when investors have optimistic expectations about their financial well-being and the
overall economy in coming months, the equity mutual funds receive 7.06% higher flows,
after controlling for different fund characteristics. But one might argue that the higher
inflows might just be due to the popularity of a particular investment objective category
("hot style") or favorable current macroeconomic conditions. To address this concern, we
include a category flow variable along with two sets of macroeconomic variables -financial and real economy -- that proxy for current macroeconomic conditions in our
regression specification in columns (B) and (C). We find that the sign and statistical
significance remains unchanged but the economic significance of the investor
expectations coefficient b in column (B) diminishes marginally to 5.7% even in the
presence of lagged category flow and financial variables. Column (C) reports regression
results after controlling for both financial and real economy factors. Unlike financial
variables, we find that all coefficient estimates related to real-economy variables are
statistically insignificant and hence, have little or no ability in predicting future equity
fund flows. But consistent with our previous results, we find that the economic
magnitude and statistical significance of our investor expectations coefficient b is robust
to the inclusion of both financial and real-economy variables that proxy for current
macroeconomic conditions.

40

Following Sirri and Tufano (1998), we include different fund characteristics in

our regression specification in column (D). The results show that investors not only
consider fund-specific characteristics when making their fund purchase decisions as
documented by prior research, but also consider their own expectations about future
economic conditions. Specifically, we find that, on average, when INVEXP increases by
one standard deviation, future equity fund flows increase by 6.6% (0.0015*11.03*4)
even after controlling for different fund characteristics. This is a new and economically
significant result that empirically supports our first hypothesis. Further, we investigate
the robustness of our results in the presence of objective category flows and existing
macroeconomic conditions. Columns (E) and (F) report the results with category flow
and financial variables and both sets of macroeconomic control variables, respectively.
Importantly, our results remain robust to inclusion of these control variables in column
(E) and (F).
In Table 4, we repeat our analysis from the previous table using alternative
expectations proxies. This analysis emphasizes the informational advantages of INVEXP
and helps to differentiate it from the existing expectations proxies. Columns (A) to (C)
report the results of regression using lagged UMEXP as a proxy for investor expectations
and columns (D) to (F) report results using lagged CBEXP. For brevity, we report only
the coefficients in front of investor expectations proxies, but control for different fund
characteristics and macroeconomic variables in our regression specifications. As
expected, we find that coefficient estimates for UMEXP are positive and statistically
significant. Even though, the magnitude of coefficients are smaller than that of INVEXP
after controlling for macroeconomic variables in Table 3. Similarly, coefficients that
relate CBEXP to fund flows are positive but statistically insignificant when we control
for existing macroeconomic conditions. These results, in addition to results presented in

41

Panel B of Table 1, clearly highlight the informational advantage that INVEXP has over
existing expectations proxies, particularly CBEXP, in predicting future fund flows.

2.4.2

Role of Information Uncertainty in Fund Purchase Decisions

Consistent with our second hypothesis, we argue that investor expectations play

an important role in mutual fund purchase decisions particularly in the case of hard-tovalue funds characterized by high information uncertainty. Because investors are unable
to evaluate future fund quality based on noisy and poor fund-specific information, they
put less weight on historical fund-specific information with high information uncertainty
and more weight on their economic expectations when making fund purchase decisions.
To examine the conditional effect of INVEXP on the subsequent flows of funds with
higher information uncertainty, we run the following panel regression as our base
specification
FLOWSi,t = a + b1FIUINVEXPt-1 + b2INVEXPt-1 + b3FIU + c1Perfi,t-1
+ c2FundAgei,t-1 + c3FundSizei,t-1 + c4TotalFeesi,t-1 +c5FamilySizei,t-1
+ dCategoryFlowst-1+ Controlst-1 + ei,t,

(3)

where FIU is the representative dummy variable for fund information uncertainty
proxies, INVEXPt-1 is the level of the investor expectations index at time t-1,
FIUINVEXPt-1 captures the differential impact of investor expectations on flows into
funds with higher information uncertainty compared to funds with lower information
uncertainty. Our coefficient of interest is b1. Following the previous literature, we include
lagged fund-specific controls such as fund performance, fund age, fund size, total fees
and fund family size along with aggregate investment category flows. We also control for
macroeconomic conditions using Controlst-1 which is a vector of lagged financial and

42

real-economy control variables. We apply this base regression specification to test

empirical predictions discussed in Section II.

2.4.2.1

INVEXP and Managerial Skill Uncertainty

To test our first prediction, we use volatility in a fund's risk-adjusted performance

as a proxy for managerial skill uncertainty. Following Pastor and Stambaugh (2002), we
define managerial skill uncertainty as the variation in the fund manager's ability to
generate returns in excess of passive benchmark and non-benchmark assets. We measure
fund managerial skill based on the fund's performance in excess of two benchmarks: the
one-factor (CAPM) model (a passive benchmark asset) and the Carhart four-factor model
(passive non-benchmark assets). For robustness checks, we also condition our fund
performance specifications on the macroeconomic variables as in Zheng (1999). The
following are different fund performance measure specifications:
1. Fund return in excess of the one-factor model:
, , =  +  

(4)

,  + !,

2. Fund return in excess of the conditional one-factor model:


, , =  + 



,  + "
#$  

, & + !,

(5)

3. Fund return in excess of the Carhart four-factor model:

'
'
'
'
, , = ' + ,(
) + ,*+
), + ,-.
/) + ,0
)) + !,

(6)
4. Fund return in excess of the conditional Carhart four-factor model:

43

'
'
'
'
, , = ' + ,(
) + ,*+
), + ,-.
/) + ,0
)) +

'
'
",(
($  ) ) + ",*+
($  ), ) +
'
'
",-.
($  /) ) + ",0
($  )) ) + !,

(7)

where zt-1 is the vector of lagged predetermined variables discussed in Ferson and Schadt
(1996)15 and 2i is the vector of factor loadings on the predetermined variables. By
incorporating these predetermined variables in these asset-pricing models, we control for
any variations in excess fund returns due to public information. Moreover, the choice of
such broad fund performance specifications is motivated by the lack of a definitive or
uncontroversial managerial skill measure and the urge to test the robustness of our
results.
To obtain a fund's risk-adjusted performance, we follow the methodology of Sirri
and Tufano (1998). We estimate the time-series regression (for both unconditional and
conditional models) of excess fund returns on excess market return for the CAPM model
and excess market return, size, value and momentum for Carhart four-factor model using
all available monthly data. Then, we estimate the expected return implied by the models
and take its difference with the observed excess fund return. This difference is defined as
fund's risk-adjusted performance and acts as a proxy for fund managerial skill.16
We define managerial skill uncertainty as the time-series standard deviation of
the fund's risk-adjusted performance over the past 12 months. Using the volatility of the
fund performance, we classify funds in the top quintile of fund performance volatility as
ones that signal higher managerial skill uncertainty. We construct a dummy variable,

15

These public information variables include: (1) the lagged level of the one-month Treasury bill yield, (2)
the lagged dividend yield of the CRSP value-weighted NYSE and AMEX stock index, (3) the lagged
default or quality spread, (4) the lagged term spread in the bond market.
16

For example, see Berk and Green (2004). We calculate the quarterly fund performance as the threemonth cumulative excess returns each quarter.
44

MSU that equals one if fund i belongs to the top quintile of fund performance volatility
in quarter t-1 and zero otherwise. We interact this dummy variable with the continuous
investor expectations variable to capture the differential impact of INVEXP on flows into
funds with the most managerial skill uncertainty compared to flows into funds with
relatively less skill uncertainty.
The results in Table 5 provide strong support for our first empirical prediction.
Funds with greater uncertainty about managerial skills receive higher inflows when
investors are optimistic about future economic conditions. In Panel A, we define
managerial skill uncertainty (MSU) as the volatility of the CAPM-adjusted fund
performance. Columns (A) to (C) report the regression results relating to the
unconditional fund performance specification in equation (4). We find that the coefficient
estimate on the interaction term b1 is positive and statistically significant, after
controlling for fund-specific characteristics such as past performance and fees. This
implies that funds with higher managerial skill uncertainty are rewarded with an increase
of 8.82% in flows when the INVEXP increases by one standard deviation at time t-1,
ceteris paribus. This is an economically important result. It strongly suggests that
investors rely on their own economic expectations, in addition to fund-specific
information, to make their investment decisions in funds with uncertain managerial skill.
Regression specifications in columns (B) and (C) test whether our results are robust to
the inclusion of investment category flows and prevailing macroeconomic conditions.
We find that our coefficient of interest, b1, remains unchanged, in sign, statistical and
economic significance. Columns (D) to (F) report the regression results based on
conditional fund performance measure specification in equation (5). These results only
strengthen our argument. The coefficient estimate b1 remains positive and statistically
significant even after accounting for any variations in fund performance due to public
information. In addition, our results are robust to the inclusion of financial control
45

variables alone or in combination with real-economy control variables which have little
impact on investors' fund purchase decisions, particularly for funds with inconsistently
performing fund managers.
To test the robustness of our results, we repeat our analysis using alternative fund
performance measures. In Panel B, we measure managerial skill uncertainty using the
volatility of fund performance adjusted for Carhart four-factors. Pastor and Stambaugh
(2002) argue that managerial skills are better captured by the Carhart four-factor model
(passive non- benchmark portfolios) than by a single-factor model (passive benchmark
portfolio). Columns (A) to (C) report the results based on unconditional fund
performance, while columns (D) to (F) report those based on conditional fund
performance measured by Carhart four-factor model in equations (6) and (7),
respectively. Consistent with prior results, investors' expectations are positively related to
fund flows into high managerial skill uncertainty funds. The results are statistically
significant and remain robust to the inclusion of fund-specific and macroeconomic
controls.
We repeat our analysis using alternative expectations proxies in Table 6. If the
alternative proxies capture investors' optimism/pessimism about future economic growth
as effectively as INVEXP, we expect them to be equally important for future flows in
funds with high managerial skill uncertainty. To test this, we interact UMEXP and
CBEXP with the high managerial skill uncertainty dummy across fund performance
specifications used in Table 5. For brevity, we report only the coefficient in front of the
interaction term between alternative expectation measures and the high managerial skill
uncertainty dummy. We find the sign of the interaction term coefficient remains positive
across different specifications, but find no consistent evidence of either UMEXP and
CBEXP being important to future flows in high managerial skill uncertainty funds.

46

Overall, these results alleviate any concerns that one might have about the informational
advantage of INVEXP over other existing investor expectations proxies.
In summary, investors' economic expectations matter in their purchase decisions
of funds that fail to unambiguously signal their high-quality managerial skill. This
conclusion holds regardless of the measure of managerial skill, conditioning on public
information, fund-specific controls and existing macroeconomic conditions.

2.4.2.2

INVEXP and Poor Quality Fund Information

In this subsection, we test our second empirical prediction that relates poor-

quality fundspecific information and subsequent fund flows. We use two different fund
characteristics as proxies for information uncertainty due to poor fund-specific
information. First, we use size of the fund family as a proxy for information uncertainty.
We categorize the fund families as small, if their total net assets (TNA) under
management (in millions) belong to the bottom quartile in each quarter. We then
construct a dummy variable, FFS, that takes value one if the fund i belongs to a small
fund family and zero otherwise. The interaction term (FFSINVEXP) measures how
investor expectations affect fund flows into small-family funds in comparison to fund
flows into large-family funds in the subsequent quarter.
Consistent with our second prediction, the results in Column (A) of Table 7 show
that the conditional effect of investor expectations on small-family fund flows, captured
by the coefficient b1, is positive and statistically significant. In general, when individual
investors hold a favorable view of the future economic conditions, funds belonging to
small sized families are more likely to receive higher inflows, despite its ambiguous
fund-specific information. In addition, the coefficient of the interaction term, b1, remains
47

statistically significant in the presence of fund-specific characteristics such as past

relative performance, total fees, age, size and fund family size. For example, smallfamily funds receive 8.82% more inflows per year when investor expectations increases
by one standard deviation, other things remaining constant. The second and third
columns in Table 7 report the same test as the first column, but with the inclusion of
category flows, financial and real-economy factors to control for current macroeconomic
conditions. The coefficient on the interaction term remains unchanged in sign and
statistical significance, however, its magnitude marginally decreases. Thus, we conclude
that the conditional effect of investor expectations on small-family fund flows is robust
to the inclusion of fund-specific and macroeconomic controls.
Second, we use fund size as a proxy for fund information uncertainty. We
categorize a fund as a small-sized fund if its total assets under management are less than
the median fund size for that quarter. We also construct a dummy variable, FSU, that
equals one if the fund is categorized as a small fund and zero otherwise. As before, we
include an interaction term (FSUINVEXP) between the FSU variable and the lagged
INVEXP variable that captures the conditional effects of investor expectations on fund
flows into small funds. Ex-ante, we expect small funds to receive greater inflow when
investors are optimistic about future economic conditions.
The results in Table 8 strongly support our prediction. We find that the
coefficient of the interaction term b1 is positive and statistically significant across all
specifications. In column (A), we report the regression results of our redesigned base
specification along with fund-specific characteristics. The sign and statistical significance
of the interaction term coefficient has two implications: (i) that the inflows in small funds
are positively related to investor expectations and (ii) that the inflows in small funds are
more sensitive to investor expectations compared to the inflows in large funds.
Specifically, we find that, on average, when the investor expectations increases by one
48

standard deviation, the small fund flows in the subsequent period increases by 9.27% per
year compared to that of larger funds, after controlling for fund-specific characteristics.
This is interesting and intuitively appealing result. Investors underweigh ambiguous
fund-specific information signals when making fund purchase decisions when they are
optimistic about future economic conditions. We then re-estimate the base regression
specification in Columns (B) and (C) and include the category flow and prevailing
macroeconomic controls. We find that the sign and the statistical significance of the
interaction term coefficient b1 remain unchanged, but the magnitude of the coefficient
marginally diminishes to 7.06%, confirming that our results are not due to any spurious
relationship between fund flows and investor expectations.

2.5

Summary and Conclusion

Much of academic literature focuses on understanding what information is

important to investors in making their investment decisions. While majority of these

studies focus on asset-specific information and current macroeconomic conditions to
explain investment decisions, very little attention is given to investors' optimism about
the future economy. This is surprising given that are strong theoretical arguments
emphasizing the role of investors' optimism in their future investment decisions.
In this paper, we investigate the importance of investors' economic optimism in
investment decisions and provide a plausible explanation to how investor optimism
enters investors' investment decisions. We show that investors' optimism about future
economic growth positively influences future fund flows even after controlling for
different fund characteristics and existing macroeconomic conditions. This result
suggests that investors increase their allocation into riskier assets, above and beyond
what can be justified by different asset characteristics and existing economic conditions,
49

when they are optimistic about the future. Further, we find that investors' optimism
becomes particularly important to investors whenever the fund-specific information is
noisy and less reliable. In particular, we find that fund flows respond more strongly to
investor optimism in funds with highly volatile past performance, funds that belong to
smaller fund families and funds with smaller fund size. Overall, this result suggests that
in situations when investors are uncertain about the quality of the asset based on its noisy
asset-specific information, they tend to put more weight on their expectations about the
future.
Another equally important contribution of this paper is that it provides a plausible
mechanism through which investors' optimism enters their fund investment decisions.
Using different fund characteristics as proxies for information uncertainty, we show that
when investors face noisy and uninformative fund-specific information, they rely more
on their economics expectations to make their fund purchase decisions. We find this is
particularly the case for: (i) funds with highly volatile past performance (high managerial
skill uncertainty), (ii) funds that belong to relatively smaller fund families and (iii)
relatively smaller sized funds.
Overall, this paper provides a set of novel empirical results that shed new light on
the role of investor expectations in individuals' investment behavior and improves our
understanding of how individuals make their investment decisions, particularly under
high information uncertainty.

50

Appendix
A. Variable Definitions
Variables

Descriptions

Flows

Net growth in the total net assets (TNA) under management of fund
i between quarter t and t-1, as a percentage of their total net assets
(TNA) under management at t-1, adjusted for returns and increase
in their total net assets due mergers between quarter t and t-1.

INVEXP

Sum of the relative scores (RS) of all five survey questions [(A3) to
(A12)] at the end of quarter t-1 divided by the relative scores total
at the end of first quarter of the base year (1985).

MSU

= 1 if fund i belongs to the top quintile of funds sorted on the

volatility
of fund manager's alpha in the quarter t-1.
= 0 otherwise.

FFSU

= 1 if fund i belongs to a fund family with total net assets (TNA)

under
management (in millions) in the bottom quartile at the end of quarter
t-1.
= 0 otherwise.

FSU

= 1 if fund i's total net assets (TNA) under management are less than
that of a median-sized fund at the end of quarter t-1.
= 0 otherwise.

Performance

Rank of fund i's raw return at the end of quarter t-1 across all equity
funds available to investors at the end of quarter t-1.

Fund Size

Natural logarithm of total net assets (TNA) under management (in

millions) of fund i at the end of quarter t.

Family Size

Natural logarithm of total net assets (TNA) under management (in

millions) of all the funds in fund i's family at the end of quarter t-1.

Expenses

Expense ratio plus the up-front load, if any, of fund i in the previous
year amortized over a seven-year holding period.

Fund Age

The number of years at the end of quarter t-1 since the fund i was
first offered to public.

Category Flows

Net growth in total net assets (TNA) under management of all funds
that belong to a particular Strategic Insight (SI) investment objective
category between quarter t-1 and t-2, as a percentage of their total
net assets (TNA) under management at t-2.

51

B. Details of Investor Expectations Index

In this appendix section, we provide a detailed description of investor
expectations index and its construction methodology.
Instead of focusing on one blanket question about how investors feel about the
future economy, each question in our index categorically focuses on the individual
household's view on the future prospects of different individual components that, in
aggregate, constitute the overall economy. For example, the first question categorically
asks the households about their view on their personal financial future which primarily
depends on the stability of their personal future income (which partly includes income
from their financial portfolios) relative to the general price level. The second question
inquires about the households' view on the overall business condition in the next 12
months. One might argue that such a question is too general in nature and might include
several possible economic and financial factors. But this is not the case. In this survey,
the interviewers ask the respondents whether the reason for their optimistic or pessimistic
expectations about overall business conditions, is because of favorable or unfavorable
news about higher consumer demand, stock market conditions, easy credit conditions,
trade deficits or political conditions such government elections. Similarly, the third
question focuses on respondents view on change in unemployment rate in the country as
a whole. That is, whether the number of people out of work will increase, decrease or
remain the same in the next 12 months. The fourth question relates to possible changes to
borrowing interest rates. Again, the question categorically focuses on borrowing interest
rate which is most likely to affect individual households' consumption and saving
decisions. The last question in our study focuses on change in general price level or
inflation. The question also probes households on a possible average percentage change
in inflation level. For our purpose, the response to the first question is enough in
determining households' expectations about future inflation level.
Now, we focus on the index construction methodology. All the responses to each
of the five survey questions mentioned above are categorized into one of the three
categories: favorable, unfavorable or indifferent. For instance, if a household responds
that a year from now she expects to be financially better off, this is categorized as
favorable response. If a household responds that she expects to be financially worse off,
this is categorized as unfavorable response and if her response is that she expects her
financial condition to be the same, the response is categorized as indifferent. Once the
responses are categorized, relative scores for each of the five questions are calculated.
For relative score calculations, UMSRC only considers favorable and unfavorable
responses and ignores the indifferent responses. The relative score is calculated as the
percentage of favorable minus the percentage of unfavorable responses, plus 100,
rounded to the nearest whole number. For example, if 65% of respondents are optimistic
about their future financial situation compared to 35% who are pessimistic, then the
relative score of that question will be 130 ((65-35)+100) for a particular period. It is
important to emphasize that we simply follow the methodology used by the University of
Michigan Survey Research Center in calculating relative scores.17 Then, we aggregate
17

For more information, please visit the following link (http://www.sca.isr.umich.edu/documents).

52

the relative scores of five questions and divide it by sum of relative scores in the first
quarter of 1985 to form our investor expectations index.

53

Figure 1
Investor Expectations and Historical Business Cycles, 1970-2008.
This figure plots the levels of investor expectations (INVEXP) index along with NBER Recessions from 1970Q1 to 2008Q4. The investor expectations
(INVEXP) index is simply the aggregate of the relative scores of the survey questions in each quarter over the entire sample and divided it by the sum of the
relative values of the first quarter of the base year (1985). The red bars indicates the recession quarters classified by NBER's Business Cycle Dating Committee.

54

Figure 2
Components of Investor Expectations, 1970-2008.
This figure plots the relative scores of five individual expectations questions along with the levels of the
investor expectations (INVEXP) index from 1970Q1 to 2008Q4. The relative score is calculated as the
percentage of favorable minus the percentage of unfavorable responses of each expectation question, plus
100, rounded to the nearest whole number. Panel A shows the relative scores of the survey question related
to investors' expectations about their personal financial well being in next 12 months. Panel B plots the
relative scores of the survey question that captures investors' expectations about the overall business
conditions in next 12 months. Panel C plots the relative scores of the survey question related to the
expected general price level (or inflation) in next 12 months. Panel D shows the relative scores of the
survey question related to expected unemployment rate in next 12 months. Panel E reports the relative
scores to the survey question that asks investors about their expectations of borrowing interest rate in next
12 months. Finally, the investor expectations (INVEXP) index is simply the aggregate of the relative
scores of the survey questions in each quarter over the entire sample and divided it by the sum of the
relative values of the first quarter of the base year (1985). Panel F plots the levels of INVEXP index over
the entire sample period. The bars in each panel indicates the NBER recession periods.
55

Table 1
Data Description And Validation of Investor Expectations (INVEXP), 1970-2008.
Panel A reports the descriptive statistics investor expectations index (INVEXP) and its five components.
Statistics include mean, standard deviation, Augmented Dickey-Fuller (ADF) stationarity test statistic
(with a constant and 4 lags) and autocorrelation coeffici0ents (up to 4 lags). INVEXP is calculated as the
equally-weighted average of the relative scores (the percentage of favorable responses minus the
percentage of unfavorable responses, plus 100) of all the five survey question components, with the base
year of 1985. The survey components include PFEXP, the relative score of expected change in personal
finances; BCEXP, the relative score of expected change in business conditions in the economy; INFEXP,
the relative score of expected change in inflation; UEREXP, the relative score of expected change in
unemployment; and IREXP, the relative score of expected change in borrowing interest rate. Panel B
reports the correlation coefficients of INVEXP and other existing expectations proxies with
contemporaneous state variables which predict future economic conditions. Existing expectations proxies
include UMEXP, the University of Michigan Expectation Index, and CBEXP, the Conference Board
Expectations index. The state variables include TERM, the difference in yields of 3-month T-bill and 10year government bond; dSIR, the changes in short-term (3-month T-bill) interest rate; dIndProd, the log
growth rate in industrial production and SMRET, the quarterly return on the CRSP value-weighted index.
All data are quarterly. ***, ** and * represent 1%, 5% and 10% confidence levels, respectively.

Panel A: Investor Expectations and its Components

Mean

Std.

Min

Max

ADF

Dev

Autocorrelations

Lag 1

Lag 2

Lag 3

Lag 4

INVEXP

90.64

11.03

62.87

122.15

-4.01

0.79

0.65

0.54

0.39

156

PFEXP

121.90

10.06

92.00

140.00

-2.28

0.85

0.81

0.72

0.66

156

BCEXP

108.17

13.59

73.00

146.00

-4.22

0.79

0.59

0.43

0.29

156

INFEXP

80.50

17.50

23.00

112.00

-3.73

0.61

0.44

0.45

0.35

156

UEMEXP

69.82

25.72

37.00

126.00

-4.74

0.78

0.60

0.45

0.27

156

IREXP

49.26

15.66

26.00

139.00

-3.99

0.79

0.61

0.51

0.36

156

Panel B: Correlations with State Variables related to Future Economic Conditions

TERMt

dSIRt

dIndProdt

SMRETt

INVEXPt
1

INVEXPt

0.50***

-0.20**

0.23***

0.18**

INVEXPt-1

0.51***

0.04

0.40***

0.01

UMEXPt

0.16**

0.15*

0.48***

0.09

UMEXPt-1

0.11

0.10

0.37***

-0.06

CBEXPt

0.09

0.32***

0.65***

0.09

CBEXPt-1

0.00

0.18**

0.46***

-0.06

56

UMEXPt

0.36**

0.42**

0.80***

Table 2
Mutual Fund Sample Description, 1970-2008.
This table summarizes the cross-sectional characteristics of mutual fund flows and other fund-specific characteristics over the entire sample period from 1970 to
2008. In first three columns, we report the number of observations, means and standard deviations of cross-sectional averages across all domestic equity mutual
funds over the entire sample. Rest of the columns report the means and standard deviations of the cross-sectional averages across all domestic equity over last
four decades of 1970s, 1980s, 1990s and 2000s. The fund-specific characteristics include Fund Returns, Fund Size, Fund Age, Family Size and Total Fees. Fund
Returns are defined as the historical raw returns net of expenses with a quarterly investment horizon. Fund Size is the total net assets under management of a
fund at the end of each quarter. Fund Age is the difference between fund's inception date and the current quarter time t, in years. Family Size is the sum of the
total net assets of all the funds under the management of the fund family at the end of each quarter. Total Fees are defined as the expense ratio plus the up-front
load amortized over a seven-year holding period. Total Fees are reported on the annual basis.
Full Sample

1970s

1980s

1990s

2000s

Obs.

Mean

Std.

Mean

Std.

Mean

Std.

Mean

Std.

Mean

Std.

Fund Flows (%)

359,294

9.57

42.29

0.44

13.71

5.75

32.10

18.22

62.19

14.34

63.25

Fund Return (%)

Fund Size
($ millions)
Fund Age (years)
Family Size
($ millions)
Total Expenses
(% annual)

369,338

2.29

4.85

1.72

5.04

3.69

4.82

3.69

4.94

-0.21

4.58

361,564

309.75

1254.49

133.99

274.92

203.23

422.26

424.95

1731.61

495.37

2737.00

366,107

12.62

12.40

16.09

12.94

17.10

14.82

9.44

12.58

7.32

8.93

33079.80

55.99

69.24

71.54

72.56

11964.16

32225.06

42973.21

107382.60

0.77

1.82

0.67

1.63

0.75

0.07

0.78

1.32

0.87

312,361 13017.33
99,215

1.56

57

Table 3
Regression of Fund Flows on INVEXP, 1970-2008.
This table reports OLS coefficient estimates of six different specifications of the panel regression described
in equation (2). The dependent variable is Flows which measures the net flows in fund i between time t-1
and t. The independent variables include INVEXP which measures investors' optimism/pessimism about
the future economic conditions over the next 12 months at time t-1. The coefficient of INVEXP is
multiplied by 100. Perf measures the relative rank of fund i's performance at time t-1, Fund Age measures
the number of years since fund inception at time t-1, Fund Size is natural logarithm of fund i's total net
assets at time t-1, FamilySize is natural logarithm of total net assets under fund i's family at time t-1, Total
Fees is the total fund fees (operating expenses plus 1/7th of front end load fees) at time t-1. CategoryFlows
is the total inflows at time t-1 into each SI investment objective category. Macroeconomic Controls
includes Financial and Real-economy variables at time t-1. Financial variables include default spreads
(DEF), term spreads (TERM), value weighted CRSP stock market returns (SMRET), changes in short-term
interest rate (dSIR). Real-economy variables include growth in industrial production (dIndProd), real
personal consumption expenditure (dRPCE), real personal disposable income (dRPDI) and unemployment
rate (dUNEMR). The data spans the period of 1970Q1 to 2008Q4. Standard errors reported in parentheses
below the coefficient estimates are clustered for time. ***,** and * represent 1%, 5% and 10% confidence
levels, respectively.

INVEXPt-1
Perfi,t-1
Fund Agei,t-1
Fund Sizei,t-1
Total Feesi,t-1
Family Sizei,t-1
Category Flowt-1
Defaultt-1
Termt-1
SMRett-1
dSIRt-1
dIndProdt-1
dRPCEt-1
dRPDIt-1
dUNEMPt-1
Clustering (Fund)
Observations

Dependent Variable: Net individual fund flows, FLOWSi,t

(A)
(B)
(C)
(D)
(E)
0.1638***
0.1294***
0.1489***
0.1523***
0.0949**
(0.0541)
(0.0461)
(0.0561)
(0.0566)
(0.0409)
0.1324***
0.1202***
(0.0131)
(0.0118)
-0.0011***
-0.0008***
(0.0002)
(0.0002)
-0.0549***
-0.0569***
(0.0023)
(0.0024)
-1.9744***
-2.2398***
(0.6294)
(0.7151)
0.0153***
0.0183***
(0.0012)
(0.0012)
1.9907***
1.9856***
1.4858***
(0.1019)
(0.1019)
(0.1271)
-8.0498***
-7.9582***
-8.6670***
(1.0821)
(1.2939)
(1.5475)
-0.7830**
-0.8388**
-0.2956
(0.3494)
(0.3444)
(0.3446)
-0.0084
-0.0149
0.0234
(0.0468)
(0.0449)
(0.0335)
-0.0147
-0.0138
-0.0242
(0.0188)
(0.0221)
(0.0187)
-0.3691
(0.4012)
-0.0006
(0.0018)
0.0025
(0.0041)
-0.0015
(0.0012)
No
No
No
Yes
Yes
359,294
359,294
359,294
293,587
293,587
58

(F)
0.0912**
(0.0451)
0.1203***
(0.0118)
-0.0008***
(0.0002)
-0.0569***
(0.0024)
-2.2444***
(0.7160)
0.0183***
(0.0012)
1.4740***
(0.1174)
-7.7134***
(1.8523)
-0.2901
(0.3401)
0.0180
(0.0377)
-0.0339
(0.0263)
0.1998
(0.3096)
0.0001
(0.0021)
0.0002
(0.0042)
-0.0008
(0.0011)
Yes
293,587

Table 4
Regression of Fund Flows on Other Expectations Proxies, 1970-2008: Robustness Checks.
This table presents robustness checks of regression specifications in Table 3. The dependent variable is
Flows which measures the net flows in fund i between time t-1 and t. Other Expectations Proxies include
UMEXP, the University of Michigan Expectations Index and CBEXP, the Conference Board Consumer
Expectations Index. The coefficients of UMEXP and CBEXP are multiplied by 100. We control for fund
characteristics which include Perf, the relative rank of fund i's performance at time t-1, FundAge, the
number of years since fund inception at time t-1, FundSize, the natural logarithm of fund i's total net assets
at time t-1, TotalFees, the total fund fees (operating expenses plus 1/7th of front end load fees) at time t-1,
FamilySize, the natural logarithm of total net assets under fund i's family at time t-1 and CategoryFlows,
the total inflows at time t-1 into each SI investment objective category. Financial variables include default
spreads (DEF), term spreads (TERM), value-weighted CRSP stock market returns (SMRET), changes in
short-term interest rate (dSIR). Real-economy variables include growth in industrial production
(dIndProd), real personal consumption expenditure (dRPCE), real personal disposable income (dRPDI) and
unemployment rate (dUNEMR). The data spans the period of 1970Q1 to 2008Q4. Standard errors reported
in parentheses below the coefficient estimates are clustered for fund and time. ***,** and * represent 1%,
5% and 10% confidence levels, respectively.

Dependent Variable: Net Individual Fund Flows - FLOWSi,t

UMEXPt-1

(A)

(B)

(C)

0.2046***

0.0728**

0.0641**

(0.0365)

(0.0291)

(0.0319)

CBEXPt-1
Fund Characteristics

Yes

Financial Variables
Real-Economy Variables
Clustering (Fund &
Time)
Observations

Yes

Yes

Yes

Yes

(D)

(E)

(F)

0.1332***

0.0360

0.0129

(0.0336)

(0.0254)

(0.0305)

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

293,587

293,587

293,587

271,056

271,056

271,056

59

Table 5
Relationship Between INVEXP And Managerial Skill Uncertainty, 1970-2008.
This table reports panel regression coefficient estimates of the equation (3). The dependent variable is
FLOWS which measures the net flows in fund i between time t-1 and t. The independent variables include
MSU x INVEXP, the interaction term between funds with high fund manager skill uncertainty and
INVEXP between t-2 and t-1. The coefficient of MSU x INVEXP is multiplied by 100. INVEXP, the level
of investors' expectations about the future economic conditions at time t-1; MSU, which measures the
uncertainty related to managerial skill as the volatility of the fund performance in excess of CAPM model
(Panel A) and Carhart four-factor model (Panel B) over past 12 months and equals 1 for the funds with
time-series standard deviation of fund performance in top quintile at time t-1 and zero otherwise. The fund
performance in Panel A and B is defined as sum of the intercept from the time-series regression of fund
returns on the CAPM and Carhart model and their residual over the entire sample. For robustness checks,
we reestimate the fund performance conditionally using equation (5) based on Ferson and Schadt (1996).
Fund-specific controls include Perf, the relative rank of fund i's performance at time t-1, FundAge, the
number of years since the fund inception at time t-1, FundSize, the natural logarithm of fund i's total net
assets at time t-1, TotalFees, the total fund fees at time t-1, FamilySize, the natural logarithm of TNA under
fund i's family at time t-1. CategoryFlows is the total inflows at time t-1 into each SI investment objective
category. Financial variables include default spreads, term spreads, value-weighted CRSP stock market
returns, changes in short-term interest rate. Real economy variables include growth in industrial
production, real personal consumption expenditure, real personal disposable income and unemployment
rate. The data spans from 1970Q1 to 2008Q4. Standard errors reported in parentheses below are clustered
for fund and time. ***,** and * represent 1%, 5% and 10% confidence levels, respectively.
Panel A: CAPM Adjusted Performance
Unconditional Model
(A)
(B)
(C)
0.0618**
0.0598**
0.0599**
MSU x INVEXPt-1
(0.0271)
(0.0266)
(0.0267)
0.0014**
0.0009**
0.0008*
INVEXPt-1
(0.0006)
(0.0004)
(0.0005)
-0.0838*** -0.0763*** -0.0763***
MSU
(0.0264)
(0.0253)
(0.0254)
0.1321*** 0.1201*** 0.1202***
Perfi,t-1
(0.0130)
(0.0118)
(0.0118)
-0.0008*** -0.0005**
-0.0005**
Fund Agei,t-1
(0.0002)
(0.0002)
(0.0002)
-0.0540*** -0.0561*** -0.0561***
Fund Sizei,t-1
(0.0024)
(0.0024)
(0.0024)
-1.9690*** -2.2334*** -2.2380***
Total Feesi,t-1
(0.6237)
(0.7094)
(0.7104)
0.0151*** 0.0181*** 0.0181***
Family Sizei,t-1
(0.0012)
(0.0012)
(0.0012)
1.4772*** 1.4650***
Category Flowt-1
(0.1268)
(0.1171)

Conditional Model
(D)
(E)
0.0772**
0.0730**
(0.0326)
(0.0316)
0.0014**
0.0008**
(0.0006)
(0.0004)
-0.1003*** -0.0926***
(0.0286)
(0.0277)
0.1320*** 0.1200***
(0.0130)
(0.0118)
-0.0008*** -0.0005**
(0.0002)
(0.0002)
-0.0539*** -0.0560***
(0.0024)
(0.0024)
-1.9701*** -2.2339***
(0.6237)
(0.7092)
0.0151*** 0.0180***
(0.0012)
(0.0012)
1.4767***
(0.1267)

(F)
0.0732**
(0.0317)
0.0008*
(0.0005)
-0.0927***
(0.0277)
0.1201***
(0.0118)
-0.0005**
(0.0002)
-0.0560***
(0.0024)
-2.2386***
(0.7101)
0.0181***
(0.0012)
1.4643***
(0.1169)

Macroeconomic Controls
Financial
Variablest-1
Real Economy
Variablest-1
Clustering (Fund
& Time)
Observations

Yes

Yes

Yes

Yes

Yes
Yes

Yes

Yes

Yes

Yes

Yes

Yes

293,587

293,587

293,587

293,587

293,587

293,587

60

(Table 5 continued from previous page)

Panel B: Carhart 4-factor Adjusted Performance
Unconditional Model
(A)
(B)
(C)
0.0970***
0.0931***
0.0930***
MSU x INVEXPt-1
(0.0329)
(0.0318)
(0.0319)
0.0013**
0.0008*
0.0008
INVEXPt-1
(0.0006)
(0.0004)
(0.0005)
-0.1062*** -0.0985*** -0.0984***
MSU
(0.0290)
(0.0281)
(0.0282)
0.1323***
0.1202***
0.1203***
Perfi,t-1
(0.0131)
(0.0118)
(0.0118)
-0.0008***
-0.0006**
-0.0006**
Fund Agei,t-1
(0.0002)
(0.0002)
(0.0002)
-0.0543*** -0.0564*** -0.0564***
Fund Sizei,t-1
(0.0024)
(0.0024)
(0.0024)
-1.9669*** -2.2325*** -2.2371***
Total Feesi,t-1
(0.6257)
(0.7115)
(0.7124)
0.0152***
0.0182***
0.0182***
Family Sizei,t-1
(0.0012)
(0.0012)
(0.0012)
1.4794***
1.4672***
Category Flowt-1
(0.1270)
(0.1172)
Macroeconomic Controls
Financial
Yes
Yes
Variablest-1
Real Economy
Yes
Variablest-1
Clustering (Fund
Yes
Yes
Yes
& Time)
293,587
293,587
293,587
Observations

61

Conditional Model
(D)
(E)
(F)
0.0773**
0.0726**
0.0727**
(0.0326)
(0.0316)
(0.0317)
0.0014**
0.0008**
0.0008*
(0.0006)
(0.0004)
(0.0005)
-0.1003*** -0.0923*** -0.0924***
(0.0286)
(0.0278)
(0.0278)
0.1320***
0.1200***
0.1201***
(0.0130)
(0.0118)
(0.0118)
-0.0008***
-0.0005**
-0.0005**
(0.0002)
(0.0002)
(0.0002)
-0.0539*** -0.0560*** -0.0560***
(0.0024)
(0.0024)
(0.0024)
-1.9700*** -2.2339*** -2.2386***
(0.6237)
(0.7092)
(0.7101)
0.0151***
0.0180***
0.0181***
(0.0012)
(0.0012)
(0.0012)
1.4768***
1.4643***
(0.1267)
(0.1169)
Yes

Yes
Yes

Yes

Yes

Yes

293,587

293,587

293,587

Table 6
Relationship Between Managerial Skill Uncertainty And Other Expectations Proxies, 1970-2008: Robustness Checks.
This table presents robustness checks of regression specifications in Table 5. The dependent variable is FLOWS which measures the net flows in fund i between time
t-1 and t. Other Expectations Proxies include UMEXP, the University of Michigan Expectations Index and CBEXP, the Conference Board Consumer Expectations
Index. The variables of interest are the MSU x UMEXP and MSU x CBEXP which capture the relationship between funds with high fund manager skill uncertainty,
UMEXP and CBEXP between t-2 and t-1. The interaction term coefficients are multiplied by 100. Panel A and B present results with unconditional and conditional
fund performance adjusted for CAPM model and Carhart four factor model, respectively. Fund Characteristics include Perf, the relative rank of fund i's performance
at time t-1, Fund Age, the number of years since the fund inception at time t-1, Fund Size, the natural logarithm of fund i's total net assets at time t-1, Total Fees, the
total fund fees at time t-1, Family Size, the natural logarithm of total net assets under fund i's family at time t-1 and Category Flows, the total inflows at time t-1 into
each SI investment objective category. Financial variables include default spreads, term spreads, value-weighted CRSP stock market returns, changes in short-term
interest rate. Real-economy variables include growth in industrial production, real personal consumption expenditure, real personal disposable income and
unemployment rate. The data spans from 1970Q1 to 2008Q4. Standard errors reported in parentheses below are clustered for fund and time. ***,** and * represent
1%, 5% and 10% confidence levels, respectively.
Panel A: CAPM Adjusted Performance
Unconditional Model
Conditional Model
(A)
(B)
(C)
(D)
(A)
(B)
(C)
(D)
0.0387
0.0418
0.0276
0.0337
MSU x UMEXPt-1
(0.0293)
(0.0279)
(0.0292)
(0.0282)
0.0296
0.0289
0.0171
0.0184
MSU x CBEXPt-1
(0.0240)
(0.0220)
(0.0200)
(0.0200)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Main Effects
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Fund Characteristics
Yes
Yes
Yes
Yes
Financial Variables
Yes
Yes
Yes
Yes
Real-Economy Variables
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Clustering (Fund & Time)
293,587
293,587
271,056
271,056
293,587
293,587
271,056
271,056
Observations
Panel B: Carhart 4-factor Adjusted Performance

MSU x UMEXPt-1

(A)
0.0507*
(0.0290)

MSU x CBEXPt-1
Main Effects
Fund Characteristics
Financial Variables
Real-Economy Variables
Clustering (Fund & Time)
Observations

Yes
Yes

Yes
293,587

Unconditional Model
(B)
(C)
0.0607*
(0.0289)
0.0339
(0.0220)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
293,587
271,056

62

(D)

0.0375*
(0.0210)
Yes
Yes
Yes
Yes
Yes
271,056

(A)
0.0258
(0.0298)

Yes
Yes

Yes
293,587

Conditional Model
(B)
(C)
0.0327
(0.0280)
0.0162
(0.0200)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
293,587
271,056

(D)

0.018
(0.0200)
Yes
Yes
Yes
Yes
Yes
271,056

Table 7
Relationship Between INVEXP And Smaller Fund Families, 1970-2008.
This table reports panel regression coefficient estimates of equation (3) where FLOWS is the dependent
variable and measures the net flows in fund i between time t-1 and t, FFS x INVEXP is the interaction term
between funds with smaller sized fund families and INVEXP between t-2 and t-1. The coefficient of FFS x
INVEXP is multiplied by 100. INVEXP is the level of investor expectations about the future economic
conditions at time t-1, FFS measures the information uncertainty related to funds that belong to relatively
small fund families and is defined as a dummy variable that equals 1 if the fund belongs to a small fund
family and zero otherwise. We categorize the fund families as small, if their total net assets (TNA) under
management (in millions) belong to the bottom quartile at time t-1. Perf measures the relative rank of fund
i's performance at time t-1, FundAge measures the number of years since fund inception at time t-1,
FundSize is natural logarithm of fund i's total net assets at time t-1, TotalFees is the total fund fees
(operating expenses plus 1/7th of front end load fees) at time t-1, FamilySize is natural logarithm of total
net assets under fund i's family at time t-1. CategoryFlows is the total inflows at time t-1 into each SI
investment objective category. Financial variables include default spreads, term spreads, value-weighted
CRSP stock market returns, changes in short-term interest rate. Real-economy variables include growth in
industrial production, real personal consumption expenditure, real personal disposable income and
unemployment rate. The data spans from 1970Q1 to 2008Q4. Standard errors reported in parentheses
below are clustered for fund and time. ***,** and * represent 1%, 5% and 10% confidence levels,
respectively.
Dependent Variable: Net Individual Fund Flows - FLOWSi,t
(A)
(B)
0.0711**
0.0696**
FFS x INVEXPt-1
(0.0304)
(0.0299)
0.0013**
0.0008*
INVEXPt-1
(0.0006)
(0.0004)
-0.0771***
-0.0619**
FFS
(0.0261)
(0.0258)
0.1324***
0.1202***
Perfi,t-1
(0.0131)
(0.0118)
-0.0011***
-0.0008***
Fund Agei,t-1
(0.0002)
(0.0002)
-0.0548***
-0.0569***
Fund Sizei,t-1
(0.0023)
(0.0024)
-1.9841***
-2.2347***
Total Feesi,t-1
(0.6322)
(0.7142)
0.0137***
0.0182***
Family Sizei,t-1
(0.0012)
(0.0012)
1.4851***
Category Flowt-1
(0.1272)
Macroeconomic Controls
Yes
Financial Variablest-1
Real Economy Variablest-1
Clustering (Fund & Time)
Observations

Yes
293,587

63

Yes
293,587

(C)
0.0694**
(0.0300)
0.0007
(0.0005)
-0.0614**
(0.0258)
0.1203***
(0.0118)
-0.0008***
(0.0002)
-0.0569***
(0.0024)
-2.2391***
(0.7151)
0.0183***
(0.0012)
1.4734***
(0.1175)
Yes
Yes
Yes
293,587

Table 8
Relationship Between INVEXP And Smaller Funds, 1970-2008.
This table reports panel regression coefficient estimates of equation (3) where FLOWS is the dependent
variable and measures the net flows in fund i between time t-1 and t, FSU x INVEXP is the interaction
term between funds with smaller sized funds and INVEXP between t-2 and t-1. The coefficient of FSU x
INVEXP is multiplied by 100. INVEXP is the level of investors' expectations about the future economic
conditions at time t-1, FSU measures the information uncertainty related to funds that are relatively small
in size and is defined as a dummy variable that equals 1 if the fund's total net assets under management are
less than that of median fund size at time t-1 and zero otherwise. Perf measures the relative rank of fund i's
performance at time t-1, FundAge measures the number of years since fund inception at time t-1, FundSize
is natural logarithm of fund i's total net assets at time t-1, TotalFees is the total fund fees (operating
expenses plus one-seventh of front end load fees) at time t-1, FamilySize is natural logarithm of total net
assets under fund i's family at time t-1. CategoryFlows is the total inflows at time t-1 into each SI
investment objective category. Financial variables include default spreads, term spreads, value-weighted
CRSP stock market returns, changes in short-term interest rates. Real-economy variables include growth in
industrial production, real personal consumption expenditure, real personal disposable income and
unemployment rate. The data spans from 1970Q1 to 2008Q4. Standard errors reported in parentheses
below are clustered for fund and time . ***,** and * represent 1%, 5% and 10% confidence levels,
respectively.

Dependent Variable: Net Individual Fund Flows - FLOWSi,t

(A)
(B)
0.1400**
0.1354**
FSU x INVEXPt-1
(0.0575)
(0.0566)
0.0007**
0.0001
INVEXPt-1
(0.0004)
(0.0005)
-0.2016***
-0.2016***
FSU
(0.0521)
(0.0508)
0.1316***
0.1195***
Perfi,t-1
(0.0131)
(0.0118)
-0.0010***
-0.0007***
Fund Agei,t-1
(0.0002)
(0.0002)
-0.0685***
-0.0713***
Fund Sizei,t-1
(0.0030)
(0.0029)
-1.9353***
-2.2017***
Total Feesi,t-1
(0.6010)
(0.6857)
0.0151***
0.0181***
Family Sizei,t-1
(0.0012)
(0.0011)
1.4789***
Category Flowt-1
(0.1289)
Macroeconomic Controls
Yes
Financial Variablest-1
Real Economy Variablest-1
Clustering (Fund & Time)
Observations

Yes
293,587

64

Yes
293,587

(C)
0.1345**
(0.0567)
0.0001
(0.0005)
-0.2007***
(0.0509)
0.1195***
(0.0118)
-0.0007***
(0.0002)
-0.0713***
(0.0029)
-2.2052***
(0.6863)
0.0181***
(0.0012)
1.4712***
(0.1200)
Yes
Yes
Yes
293,587

Chapter 3
To Group or Not to Group?
Evidence from Mutual Funds

65

3.1

Introduction
There is a large body of theoretical and empirical studies across a variety of

disciplines that examines the benefits of group versus individual decision making. The
idea that a group mind is distinctly different from a single one was first put forward by
the social psychologist Le Bon (1896). There is wide experimental evidence that implies
inferior choices made within groups than among individuals resulting from extreme
decisions by a dominant player in a team or a reduction in critical thinking for the sake of
unanimity with other group members.18 In economics, the negative effect of group
decision making is often linked to possible productivity losses caused by free-riding by
some team members (e.g., see Alchian and Demsetz, 1972; Holmstrom, 1982; Rasmusen,
1987; Nalbantian and Schotter, 1997).
There is an alternative literature that highlights the benefits of decision making
process within groups. Sah and Stiglitz (1986, 1991) point out that the aggregate group
opinion is the average opinion of all group members. Sharpe (1981) shows that teams in
the portfolio management industry are able to achieve diversification of style and
judgment. Barry and Starks (1984) provide a theoretical setting suggesting that teams in
investment funds may reduce portfolio risk. Yet, very few empirical studies provide
support to the opinion and risk diversification theories of groups. Hamilton, Nickerson,
and Owan (2003) find that teams increase worker productivity, and that this increase is
more apparent among earliest team members, high-ability workers, and heterogeneous

18

See Wallach and Kogan (1965) and Stoner (1968) for the phenomenon known as risky shifts,
Moscovici and Zavalloni (1969), Kerr (1992), and Sunstein (2002) for group polarization concept, and
Janis (1982) for the notion of a groupthink. Bone, Hey, and Suckling, (1999) observe that groups have
no more consistency in decision making than individuals. Barber, Heath, and Odean (2003) find that
groups are more likely to purchase stocks than individuals for good reasons even though these reasons do
not improve performance.
66

teams. Adams and Ferreira (2010) analyze individual and group bettors in iceberg breakup betting and find that teams arrive to less extreme decisions than individuals.19
The goal of this paper is to examine the effect of teams on fund performance,
their risk-taking behavior and other fund characteristics using a large U.S. equity mutual
fund database. Our analysis has are three distinguishing features. First, we focus not only
on the examination of the individual/team split for fund performance but also on the
understanding of the value of an extra group member for the benefits of team
management. The intuition here is that any group work always leads to a tradeoff
between a larger intrinsic knowledge base of the group versus a difficulty in arriving at
optimal decisions, especially under time constraints, which are present in many job
occupancies, including the mutual fund industry. Second, we differentiate the team
impact on fund performance across geographic locations. The intuition here is that the
value of adding a new member to a team must to be higher in large cities where each
individual is more likely to bring to the group his/her unique knowledge, skills, and
networking ability. Third, we look into the relation between team member characteristics
and fund performance. The intuition here is that individual characteristics of team
members must impact team performance even when team size and location is the same.
The list of empirical finance studies that deal with group and individual decision
making is not very long. For example, Prather and Middleton (2002) find no evidence of
differences in fund performance between group and individual decision making, but they
deal with data sample with large survivorship bias. Chen, Hong, Huang, and Kubik,
(2004) find underperformance among team-managed funds, while Bar, Kempf, and
Ruenzi (2010) and Bliss, Porter, and Schwarz (2008) find that single- and team-managed
19

Other evidence in favor of team decision making is based only on studies on signaling games
experiments, such as Bornstein and Yaniv (1998), Cooper and Kagel (2004), and others. Blinder and
Morgan (2005), based on experiments simulating monetary policy decisions by central banks, show that
groups achieve better outcomes than individuals. There is also some support for the wisdom of a crowd
phenomenon advocated by Surowiecki (2005).
67

funds exhibit similar average performance but teams have lower risk-adjusted returns and
smaller portfolio risk than individual managers. However, both these studies use CRSP
data and do not account for manager characteristics. Massa, Reuter, and Zitzewitz (2010)
compare single, named, and anonymous team management practices. Kostovetsky and
Warner (2011) study manager turnover differences in equity mutual funds while
controlling for manager team size, but they do not examine fund performance issues
related to fund management structure.
Our data comes from Morningstar Direct and covers the period between January
1992 and December 2010. Some studies provide evidence of better and more precise
coverage of mutual funds by Morningstar than CRSP (e.g., see Elton, Gruber, and Blake,
2001; Massa, Reuter, and Zitzewitz, 2010; Karagiannidis, 2010). However, these papers
do not systematize the disparity in fund management structure reporting. Therefore, as a
first step, we highlight the discrepancies between CRSP and Morningstar data on
managerial structure of funds. We show that very often CRSP reports single-managed
funds while these funds are team-managed in Morningstar, and vice versa. The existence
of these differences, which in some years in excess of 20% of the overall sample of
named equity mutual funds, could cast certain doubts on the results of many recent
studies that use fund manager-specific information using CRSP data.20 Indeed, the
impact of a team on fund performance using an exactly matched sample between CRSP
and Morningstar is very different for the two datasets. With CRSP data teams have no or
negative contribution to risk-adjusted returns computed based on unconditional and
conditional versions of Carhart (1997) model, while with Morningstar data teams show
not only positive but also often significant addition to fund performance.

20

The non-inclusive list of recent studies that use CRSP data on fund management structure include
Agarwal and Ma (2011), Bar, Kempf, and Ruenzi (2010), Chen, Hong, Huang, and Kubik (2004), Cici,
(2011), Dass, Nanda, and Wang (2011), Deuskar, Pollet, Wang, and Zheng (2011), Han, Noe, and Rebello
(2008), Kempf and Ruenzi (2007), and Nohel, Wang, and Zheng (2010).
68

Next, we examine the difference between team and single-managed funds across
various aspects of fund performance. We observe that on average funds which are teammanaged have higher risk adjusted returns than their single-managed counterparts. This
result holds steadily after accounting for a range of fund and manager characteristics and
is present across various fund investment objectives except those in aggressive growth
category. We then examine the relation between the size of a fund management team and
fund returns. We observe that this relation is non-linear. In particular, we find that threeperson teams are the largest contributors to fund performance relative to single-managed
funds. This result corroborates well with the notion of increasing problems of free-riding
and decreasing cooperation effectiveness in larger groups (e.g., Alchian and Demsetz,
1972; Holmstrom, 1982; Mueller, 2012).21 We also investigate the benefits of group
decision making across various locations. We split the sample into funds whose advisors
are located in six financial centers as defined in Christoffersen and Sarkissian (2009) and
those located in smaller cities and repeat our tests. We show that only funds located in
financial centers gain from team management, interpreting this result as highlighting the
importance of learning and information spillover effects in larger cities (e.g., see Jacobs
1969; Glaeser, 1999). Locating in financial centers helps individual members to bring
more diverse knowledge and skills (informational diversity) to their teams and is
consistent with diversification benefits arising from team work argued by Sharpe (1981).
In addition, we find among funds in financial centers that those with more heterogeneous
team members in terms of age and undergraduate institution (social category diversity)
underperform those with more homogeneous managers. These results are consistent with
potentially larger frictions and conflicts of interests associated with non-homogeneous

21

Laughlin, Hatch, Silver, and Boh (2006) find that three-person groups are necessary and sufficient to
perform better than the best individuals on highly intellective problems.
69

groups, as emphasized in Jehn, Northcraft, and Neale (1999), and career concerns issues
in the mutual fund industry raised in Chevalier and Ellison (1999b).22
Finally, we analyze whether team-managed funds exhibit different risk-taking
behavior than single-managed ones and what fund characteristics are associated with
team management. We find little evidence that team-managed and single-managed funds
differ statistically in their exposure to total risk, market risk, and idiosyncratic risk.
However, the volatility of team-managed funds is larger in economic terms than their
single-managed counterparts. Subsequently, we observe that a substantial part of this
excess volatility among funds with multiple managers comes from their statistically
larger loadings on small and value stocks. We further show that team-managed funds
lead to substantially lower turnover, more than 12% annually with a full set of fund and
manager characteristic controls. This result implies less aggressive trading within groups
of portfolio managers and, therefore, provides additional support that teams lead to less
extreme behavior. Teams also help funds bring more money: we find positive and
significant link between team management and net fund flows reflecting a recent trend in
mutual fund industry to rely more on team-managed funds. Thus, our study shows that
group-decision making in mutual fund industry has sizable performance benefits, but the
extent of these benefits depends on team size and diversity, as well as fund location.
The rest of the article is organized as follows. Section 2 presents the motivation
for our analysis and hypotheses development. Section 3 describes the fund- and managerlevel data. In section 4, we compare managerial structures reported in CRSP and
Morningstar databases and then conduct preliminary tests on the importance of team
management for fund performance using the two data sources. Section 5 presents the
main empirical findings of our paper. Section 6 examines the differences between team22

In their experimental study, Jehn, Northcraft, and Neale (1999) find that informational diversity
positively affects group performance, but diversity in social categories and values among team members
reduce this effect substantially.
70

managed and single-managed funds in terms of various measures of fund risk and several
fund characteristics. Section 7 concludes.

3.2

Motivation and Hypotheses Development

There is widespread evidence nowadays from the industry that mutual funds

prefer moving towards team management. For example, below is an excerpt from the
December 2, 2011 Reuters report:

Mutual fund star managers have gone the way of the vinyl
record: They're cool to have, expensive to get, and sometimes,
not the best quality. In their place, fund companies like Federated
Investors, Eaton Vance and Invesco are moving in favor of a
team-oriented approach. Even Fidelity Investments, home of one
of the first star managers, Peter Lynch, has switched some funds
to a team-managed approach. The move helps fund companies
defend against poaching, protect their funds returns, and shield
themselves from the level of outflows seen at competing firms
after their high-profile stars have flamed out. 23
Recent academic sources also document the same trend (e.g., Massa, Reuter, and
Zitzewitz, 2010). This evidence however stands in stark contrast with the results of
numerous experimental and empirical academic studies that have tried, but with little
success, to identify benefits of group work in various fields of social science, including
finance and economics. For instance, papers such as Chen, Hong, Huang, and Kubik,
(2004), Massa, Reuter, and Zitzewitz (2010), Bar, Kempf, and Ruenzi (2010) among
others find that team management in mutual funds provides no gains over singlemanaged funds and even often leads to inferior performance. Some literature from
economics that finds beneficial impact of teams on productivity and more balanced
23

Funds move away from star managers, favor teams, by Jessica Toonkel, December 2, 2011, Thomson
Reuters.
71

decision making, such as Hamilton, Nickerson, and Owan (2003) and Adams and
Ferreira (2009), are based on extremely limited data. Therefore, our main hypothesis,
similar to most of the aforementioned studies, states the rationale for the existence and
the spread of teamwork in fund management, namely:
H1. Fund performance is higher among team-managed funds.
Note that the value of group decision making may greatly depend on internal and
external factors. First, there are many studies that examine team performance as a
function of team size. For instance, research shows that larger teams may often perform
worse than small ones (e.g., see Thompson, 2003; Mueller, 2012). While the earlier
literature has no clear answer on the optimal number of people in a group (on average,
varies between five and ten), it is obvious that the ideal team size should depend on the
tasks performed by individuals within a group. It appears that the more diluted the tasks
are, the smaller should be the optimal group size. In this respect, Mueller (2012) argues
that if companies deal with various coordination and motivational issues, then any group
composed of five or more individuals will already see significant increases in
coordination costs within the group and diminishing motivation across members of the
group. Hence, we can state our first prediction as follows:
P1. Fund performance is non-linear in the number of team members.
Second, the value of an additional team member must be greater under those
conditions when each individual has a higher potential to enhance the overall knowledge
and resource base of the group. In the fund management industry in particular, skills,
knowledge as well as networking ability of each team member can be of great
importance to fund performance. Numerous studies have shown that those conditions are
more readily available in larger cities (e.g., see Jacobs 1969; Glaeser, 1999;
Christoffersen and Sarkissian, 2009). Indeed, larger cities, especially financial centers,
72

can provide positive externalities to portfolio managers including, but not limited to,
easier knowledge transfer, faster and more diverse business connections, and potential
access to private information. Therefore, we can now formulate our second prediction:
P2. Fund performance is higher among team-managed funds located in larger cities.
Third, it is clear that individual characteristics of team members are important for
team decision making and performance. In particular, there could be differences between
more homogeneous and less homogeneous teams. For example, if a team of mutual fund
managers includes a much more senior and experienced person then the probability of
other team members to conform to the decisions of that individual increases (e.g., see
Janis, 1982). Jehn, Northcraft, and Neale (1999) observe that while the information
heterogeneity among group members is very helpful to group performance, the social
category heterogeneity is not. Moreover, Chevalier and Ellison (1999b) point out that
fund managers have different incentives at various stages of their careers, and so they are
not likely to collaborate well within teams composed of members of various age groups.
Thus, we can now articulate our third prediction:
P3. Fund performance is higher among more homogeneous team-managed funds.
Finally, numerous studies compare individual and group decision making to the
level of risk. We follow the arguments in Sah and Stiglitz (1986, 1991), Sharpe (1981),
and Barry and Starks (1984) and assume that working in teams does not induce extreme
risk taking behavior among portfolio managers. Thus, our second hypothesis can be
stated as follows:
H2. Team-managed funds do not take excessive risk.

73

Note that given the inconclusiveness of previous studies on the impact of group decision
making on fund performance, it is imperative to deal with precise fund managerial
structure data. We specifically address this issue in the next section.

3.3

Data

3.3.1 Main Data Source

Our primary data source is Morningstar Direct (MS, henceforth), a relatively new
survivorship-bias free institutional research product offered by Morningstar, Inc. This
database provides one of the most comprehensive and in-depth coverage of open-ended
mutual funds across the globe, including the United States. Our sample covers actively
managed U.S. diversified domestic equity funds with the following investment
objectives: Aggressive Growth (includes Small Company), Growth, Growth & Income,
and Equity Income from 1992 to 2010. We exclude all sector funds from our analysis
because their portfolios are constrained to follow a particular industry and hence are not
diversified. We also exclude index funds because majority of these funds are not actively
managed. MS reports all data at the fund share class level, including the names of the
fund managers. However, different share classes of the same fund have identical
underlying portfolio with the same fund manager(s). This might lead us to multiple
counting of fund management information and bias our analysis. To avoid such biases,
we aggregate mutual fund share class level observations to one fund level observation
using a unique fund identifier in MS.
To determine whether a fund is sole-managed or team-managed at the end of a
calendar year, we use the detailed fund manager data which includes fund manager
names, the exact date a fund manager joins and leaves a particular fund. We classify a
fund as sole- or team-managed based on the number of fund managers with the fund at
74

the end of calendar year. When only one fund manager is named at the end of calendar
year, we classify that fund as sole-managed for that year. Similarly, when two or more
fund managers are named with the fund, we classify the fund as team-managed. We
remove all fund-years which have missing or anonymous fund manager names or tenure
dates from our sample.24 Our final sample covers 3,935 unique funds with 35,440
manager-fund-year observations.

3.3.2

Fund Characteristics
For each fund we obtain information on total net assets under management,

expense ratios, turnover ratios, fund inception date, and fund family name from MS. This
information helps us control for fund characteristics that are well known in the literature
to affect individual fund performance. These characteristics typically include fund size,
measured by the total net assets under management of the fund at the end of calendar
year; fund age, defined as the difference between the funds inception year and the
current year; expenses, measured by the annual net expense ratio of the fund; turnover,
measured by the turnover ratio of the fund; fund family size, measured by the total net
assets under management of the fund complex to which the fund belongs at the end of
calendar year; fund return volatility, measured by standard deviation of raw net returns of
funds over the past year. We also include net fund flows, defined as the net growth in the
total net assets of funds, as a percentage of their total net assets, adjusted for prior year
returns. To minimize the effect of outliers on our analysis, we winsorize expense ratios,
turnover and annual fund flow variables at 1% and 99% levels.

24

The proportion of blank or anonymous entries for fund manager information in our initial data sample is
only 7%. This stark difference with the percentage of anonymous funds reported in Massa, Reuter, and
Zitzewitz (2010), which was reaching 18% in some years is due to the fact that Morningstar Direct has
filled in names of managers for almost all funds (retroactively) after 2006.
75

Christoffersen and Sarkissian (2009) show that fund managers located in

financial centers earn higher returns than their peers located in smaller towns. To control
this location effect, we obtain the location information of fund advisors from MS.
Following Christoffersen and Sarkissian (2009), we define the following six cities to be
financial centers: Boston, Chicago, Los Angeles, New York, Philadelphia, and San
Francisco. If the fund advisor company is headquartered within a 50-mile radius of any
of these six cities, we classify the fund as located in the financial center.
It is important to point that our location variable differs from the previous studies.
Instead of using the headquarter location of the fund company or fund sponsor (e.g.,
Christoffersen and Sarkissian, 2009), we use the headquarter location of the fund advisor
company. For majority of funds, the fund advisor and the fund sponsor (the company that
offers the mutual fund to public) might be the same company (Chen, Hong, and Kubik,
2011). But for few funds they might be different because these funds choose to outsource
their portfolio management to third-party fund advisor companies. By choosing the fund
advisor location, we make analysis immune to the possibility of any bias due to thirdparty fund management outsourcing.

3.3.3

Fund Manager Characteristics

In any study that examines potential impact of group decision making on fund

performance, it is important to control for the influence of managers demographic

characteristics.25 The demographic information available to us includes the name(s) of
fund manager(s), the name(s) of all funds they currently manage and have managed in
the past, their start and end dates with those funds, all undergraduate and graduate

25

Unfortunately, this has not been the case in many papers which attempt to determine the impact of team
management of fund performance (e.g., Bar, Kempf, and Ruenzi, 2011; Massa, Reuter, and Zitzewitz,
2010).
76

degrees received, the year in which the degrees were granted, and the name of degreegranting institution. In addition, we also have a detailed biographical sketch for all fund
managers from MS. This sketch is provided to MS by the fund managers themselves
which includes their personal and past work experience details. Following Chevalier and
Ellison (1999a), we use these data to create four manager characteristics variables:
Manager Tenure, MBA dummy, Average SAT, and Manager Age.
Specifically, we define the manager tenure as the difference between the year
when a fund manager started as a portfolio manager for a given fund and the current
year. To create the MBA dummy variable, we use the graduate degree details of each
fund manager in our sample. We define the MBA dummy variable as one if the fund
manager received an MBA degree and zero otherwise. To construct the average SAT, we
closely follow the methodology of Chevalier and Ellison (1999a). First, we obtain the
name of the undergraduate institution for each fund manager. Then, we look for that
institutions SAT score in the 23-rd edition of Lovejoys College Guide (see Straughn
and Straughn, 1995). Most schools report the upper and lower of median verbal and math
scores for incoming student in that year. To calculate the composite SAT score for a
given school, we simply add the average of the upper and lower bounds of the verbal
score to the average of the upper and lower bounds of the math score. In few cases,
schools choose to report ACT scores instead of SAT. In those cases, we convert the ACT
to an equivalent SAT using SAT-ACT concordance tables provided by the College
Board.26
The construction of fund manager age variable is not straightforward because
very few fund managers in our sample disclose their date of birth in their biographical
sketch. To overcome this problem, we again follow the methodology proposed by
26

For more a detailed description of the construction of average SAT score, please refer to Chevalier and
Ellison (1999a).
77

Chevalier and Ellison (1999a). For managers who report their date of birth, we simply
take the difference between the year of their birth and the current year. For managers
who do not report their date of birth, we construct an approximate manager age variable
by assuming that each manager was 21 year old upon receiving their undergraduate
degree. The limited coverage of undergraduate degree year information does reduce our
sample size, but does not affect our analysis.
An important difference between Chevalier and Ellison (1999a) and our study is
that they focus only on single manager funds, while our study focuses on both singleand team-managed funds. It is relatively straightforward to create manager characteristics
for single-managed funds. But it is somewhat problematic to create manager
characteristics for teams of fund managers. Ideally, one might be able to create team
characteristics based on detailed understanding of the contribution of each team member.
Unfortunately, we do not have any these data. To overcome this problem, we simply
assume equal contribution of each team member. Hence, manager characteristics for a
team, such as manager tenure, age and SAT scores will simply be the equally-weighted
average of manager tenure, age and SAT scores of each fund manager in the team,
respectively. For the MBA dummy variable in case of teams, we define it to be one if any
one of the team members has a MBA degree and zero otherwise.

3.3.4

Fund Performance Measures

For computing fund performance measures we use each funds monthly net fund

returns from MS. We use three different performance metrics: objective-adjusted returns,
OAR, unconditional four-factor alpha, (4U), using Carhart (1997) model, and
conditional four-factor alpha, (4C), following the application of Ferson and Schadt
(1996) framework to Carhart (1997) model. We define OAR as the difference between

78

the average monthly return (net-of-fees) of a fund in the year minus the mean fund
returns across all funds for a given fund investment objective and year. We estimate each
funds unconditional and conditional risk-adjusted alphas using the following two
equations:
ri , t = i + i rm, t + si SMBt + hi HMLt + miUMDt + ei ,t ,

(1)

and

ri ,t = i + i rm ,t + s i SMB t + hi HML t + m iUMD t + biTbill rm ,t Z tTbill

+ biTerm rm ,t Z tTerm
+ ei ,t , (2)
1
1

respectively, where ri,t is the monthly net fund return less the risk-free rate (proxied by
the one-month U.S. T-bill rate), rm,t is the monthly U.S. excess market return (i.e., the
return on the CRSP Value-weighted NYSE/AMEX/Nasdaq composite index less the
one-month U.S. T-bill rate), while i is the risk-adjusted return, unconditional in Eq. (1),
(4U), and conditional in Eq. (2), (4C). SMB, HML, and UMD are returns on the size,
book-to-market, and momentum portfolios, respectively.27 In equation (2), Z tTbill
and
1
are the two lagged (demeaned) public information variables: the one-month U.S.
Z tTerm
1
Treasury bill rate (T-bill) and the term-structure spread (Term), defined as the difference
in yields on the 10-year U.S. government bond and three-month U.S. T-bill.
Funds change the number of fund managers from year to year. Therefore, we
remove all fund-years that have less than 12 monthly fund return observations and
estimate the fund alphas using their prior twelve monthly returns. Although the 12-month
horizon gives us fewer data points for the estimation than we may want, we believe that
given the high frequency of fund manager turnover, the longer (greater than one year)

27

These data are from Ken Frenchs site, http://mba.tuck.dartmouth.edu/pages/faculty/

ken.french/data_library.html.
79

estimation horizons will introduce bias in our analysis by incorrectly attributing fund
performance to a certain type management structure.

3.3.5 Summary Statistics

First, in Figure 1, we show the evolution of mutual fund management structure
from 1992 to 2010. It depicts the percentage of single-managed and team-managed funds
along with the total number of funds in each year of our sample. The total number of
funds increased from around 750 in the beginning of the sample period to more than
2,000 by 2010, peaking in 2007 with close to 2,500 funds. Consistent with reports in
other studies (e.g., Massa, Reuter, and Zitzewitz, 2010), we can see that the proportion of
single-managed funds has dropped significantly in the last two decades from almost 70%
in 1992 to around 30% in 2010.
Table 1 shows the summary statistics of mutual funds by the fund management
structure, where the data on team-managed funds is divided into funds with two
managers, three managers, four managers, and five managers or more. Panel A reports
the distribution (number and proportion in percent) of single- and team-managed funds
for each year in our sample. While all team-managed funds have increased their presence
in the industry, multiple-manager funds (five and more) have experienced the largest
relative and absolute gains in representation, four-fold from 4% in 1992 to 16% in 2010.
However, the largest proportion of team-managed funds has been directed by two
managers throughout our sample period.
Panel B of Table 1 reports three measures of performance, OAR, (4U), and
(4C), for single and team-managed funds. It also contains information about the
difference test in mean performance measures between each group of team-managed
funds and single-managed funds. We can see that team-managed funds show better
80

objective- and especially risk-adjusted performance. For example, the difference in OAR
between two-manager and single-manager funds is 0.014 per month or about 17bp per
year, while that between four-manager and single-manager funds is almost 56bp per year,
although this result is statistically insignificant. However, both fund alphas show that
three-manager funds, and, to some extent, funds managed by five or more people gain
the most relative to funds managed by a single person. For three-manager funds, the
differences in (4U) and (4C) are 43bp and 47bp per year, respectively, and these
results are significant at the 5% level. For five-plus-manager funds, the positive and
significant difference is observed only with respect to the unconditional alpha measure.
Other team sizes are not associated with significant outperformance relative to singlemanaged funds.
Panel C of Table 1 reports mutual fund characteristics other than performance
measures. These include fund volatility, total net assets (Find Size), fund age (Fund
Age), turnover, and expenses. Among other fund characteristics, the notable differences
across managerial structures include turnover and expenses. Both these measures
decrease with an increase in the number of fund managers (and expenses decrease
monotonically). In addition, fund size tends to increase with team size. There are no
obvious differences however in fund volatility and age.
Finally, Panel D of Table 1 reports fund manager characteristics for our five
managerial structure groups. We notice that the average tenure with the same fund is the
highest among single-managed funds and so are the average SAT scores. Not
surprisingly, funds with larger teams are more likely to have at least one manager with an
MBA degree. The average age of managers appears relatively stable across both singlemanaged and team-managed funds.

81

3.4

Management Structure: CRSP versus Morningstar

3.4.1

Fund Management Structure Differences

First of all, we determine the accuracy of funds management structure

information by comparing our MS sample to the widely used CRSP Survivorship Bias
Free Mutual Fund Database (CRSP, henceforth). Like MS, the unit of observation in
CRSP is the fund share class and the fund tickers are uniquely assigned to share classes.
To avoid double counting of funds management structure, we aggregate the share classlevel information to fund level for each fund. We match each fund in our MS sample to
CRSP using individual fund tickers and date of inception. In cases where the fund ticker
information is missing, we use fund names along with their date of inception for
matching purposes. We carefully do this matching by hand because there are differences
in fund naming conventions in both MS and CRSP. MS only reports the most recent
name adopted by the fund whereas CRSP reports different names adopted by the fund
over its active life. To ensure the accuracy of our matching strategy, we double check
each matched fund by hand. At the end, we are able to match 92.78% of our MS sample
funds to CRSP (3,651 out of 3,935 funds) sample between 1992 and 2010.
We also classify CRSP sample into single- or team-managed funds. For each fund
in a given calendar year CRSP reports the name of the fund manager(s) under Portfolio
Manager Name (also known as mgr_name) variable. We classify a fund as solemanaged when only one manager name is listed and classify as team-managed when two
or more managers (or phrases such as Team Managed and Investment Committee)
are listed. We remove funds from our sample that report the name of the fund company
or their advisor(s) under the manager name variable. In addition, we also remove fundyear observations for which the manager name is not available. We end up with 29,918
manager-fund-year observations in CRSP that represents an 84.42% match with our main
MS sample.
82

The table below provides an example of mismatch between the two data sources.
This example includes AARP Growth and Income Fund (CRSP Fund No: 53; MS
Fundid: FSUSA004ZG).
Fund Name (MS)
AARP Growth &
Income
AARP Growth &
Income
AARP Growth &
Income
AARP Growth &
Income
AARP Growth &
Income
AARP Growth &
Income
AARP Growth &
Income
AARP Growth &
Income

# Fund Managers
MS CRSP SEC

Fund Name (CRSP)

Year

AARP Growth & Income Fund

1992

AARP Growth Tr: Growth and

Income Fund
AARP Growth Tr: Growth and
Income Fund
AARP Growth Tr: Growth and
Income Fund
AARP Growth Tr: Growth and
Income Fund
AARP Growth Tr: Growth and
Income Fund
AARP Growth Tr: Growth and
Income Fund
AARP Growth Tr: AARP Growth
and Income Fund

1993

1994

1995

1996

1997

1998

1999

The table compares the fund name as well as the number of fund managers that manage
the fund at the end of the each calendar year for both CRSP and MS. To test the accuracy
of fund manager information in both databases, we compare this information to the one
provided by the fund to the financial regulator, the Securities and Exchange Commission
(SEC), each year. We hand collect the fund manager information from the funds
Prospectuses and other filings available on SECs EDGAR database each year. To
determine the number of fund managers in the SEC database, we count the names of fund
managers listed in the SEC filings at the end of the calendar year.28 The first and second
28

Creating the number of fund manager variable based on SEC filings is somewhat involved. We start by
hand-collecting the funds Prospectus (Form N-1A), Annual Report (Form N-30D), and Post-Effective
Amendments (Forms POS AM, 497, 485APOS and 485BPOS) available on SECs EDGAR database each
year. Funds are legally required to include the full name, title, length of service, and business experiences
of the individuals, including each member of portfolio management team who are primarily responsible for
the day-to-day management of the fund in these filings. In cases where funds employ large portfolio teams,
SEC requires the fund to provide information on at least five members who share the most significant
responsibility for the day-to-day management of the fund's portfolio, for example, the managers with the
largest percentages of assets under management. Funds are also required to disclose any change in fund
83

columns report the name of the fund given in MS and CRSP, respectively. Columns 4-6
show the number of fund managers reported in MS, CRSP, and SEC databases in a given
year, respectively. The first three rows in the last column have missing values because
we were unable to find corresponding years SEC filings on EDGARs website. This
table shows the managerial structure reported by Morningstar is consistent with SEC, but
we cannot say the same thing about CRSP data.
Table 2 reports the full extent of a misspecification in management structure
between CRSP and MS datasets for each year in our sample. Column 2 reports the
number of matched funds. We see that the overlap in funds between the two databases is
large in every year of our sample and it roughly follows the same trend as the overall
number of funds in our sample reported in Table 2. Column 3 and 4 as well as 5 and 6
report the percent of single-managed and team-managed funds in CRSP and MS
databases, respectively. We can observe that for the whole of 1990s, especially in the
beginning of the sample period, CRSP reports much more single-managed funds than
MS. Towards the 2000s, the overall proportion of single- and team-managed funds
becomes similar between the two databases. Columns 7 to 12 report misspecification
statistics. Columns 7 and 8 show the number of funds and their proportion that is
identified as single-managed funds in CRSP but are team-managed in MS. Columns 9
and 10 show the opposite problem, that is, the number of funds and their proportion that
is identified as team-managed funds in CRSP but are single-managed in MS. Finally,
column 11 gives the total number of mis-specified funds, while the last column indicates
the percent of misspecification in the overall matched sample.
manager(s) and provide information about the new manager(s) under the Securities Act through these
filings. Each of these filings contains a filing date, which refers to the date the information was made
public, and an effectiveness date, which refers to the date the information took effect. We then sort these
filings based on their effectiveness date for each calendar year. Lastly, to determine the number of fund
manager(s) in the fund, we simply count the name(s) of the fund manager(s) listed in the last SEC filing at
the end of the calendar year. Because of the difficulty of doing this exercise over our entire sample of fundyear observations, we only checked several randomly chosen funds on the consistency of their Morningstar
managerial data with SEC filings.
84

Columns 7-12 of Table 2 easily show that the largest misspecification in

managerial structure reporting between the two databases occurs in the early part of the
sample. The total misspecification is higher than 20% of the matched sample for most of
the 1990s. However, even in the 2000s, when both CRSP and MS report about the same
proportion of single- and team-managed funds (see columns 4 and 6), there is still a
significant misreporting in fund management structure that never goes below 10% of the
sample. Note that the average management structure misspecification over the whole
sample period is almost 19%. Taking into account the fact that we were not able to match
about 16% of MS sample with CRSP database, the actual misspecification in the reports
on the number of managers between the two databases is in excess of 20% during the last
two decades. The range of misspecification in CRSP is 17% to 29% for single-managed
funds and 6% to 23% for team-managed funds. Thus, Table 2 illustrates that the extent of
differences in management structure reporting between CRSP and MS databases is very
large and is likely to have a direct impact on studies using CRSP data in analyzing the
impact of teams in mutual funds returns.

3.4.2

Fund Performance Differences

Now we proceed to comparing the effect of team management on mutual fund

performance using CRSP and MS data. The regression model that we deal with has the
following general form:
Perf i ,t = c o + c1Team i ,t + 1 Fund _ Controls i ,t 1 + 2 Mgr _ Controls i ,t + 3 FE i ,t + ei ,t ,

(3)

where Perfi,t is one of our performance measures, Team is the dummy for multiplemanager funds, Fund_Controlsi,t-1 and Mgr_Controlsi,t are the sets of fund- and managerspecific characteristics, while FEi,t includes the year and fund investment objective fixed

85

effects. Our fund-level controls are lagged by one period to exclude the contemporaneous
effect that they may have on fund performance.
Table 3 reports the results of panel regression tests of our two risk-adjusted
returns, (4U) and (4C), computed in a similar way from CRSP and MS databases on a
large set of fund and manager characteristics. In this table we again use our matched
sample between the two databases. The independent variable of interest is Team, defined
as a dummy variable which equals one if the fund has two (or more) fund managers and
zero if it has only one fund manager at the end of calendar year. Most of other
independent variables are defined in Table 1. To reduce the influence of outliers, we take
the natural logs of fund size, fund age, and manager age. Variable Flows is the net
growth in total net assets under management of the fund over the past year. SAT score is
divided by 100. All fund-level controls are lagged by one period except fund age. All
regression specifications include time and investment objective fixed effects (FE), and
the standard errors are clustered by fund. Each regression model also reports the number
of observations and the adjusted R2.
Panel A of Table 3 shows full sample estimations. There are 18,437 fund-year
observations with fund controls alone, but this number drops to 10,982 after the inclusion
of manager characteristics. Columns 1-4 report the estimation output using CRSP data.
Columns 1 and 2 show the estimates for (4U), without and with fund manager controls,
respectively, while columns 3 and 4 show the corresponding estimates for (4C). We can
see that in all these regressions, the coefficient estimate on Team is negative but
statistically insignificant. This result could explain conclusions in many papers that use
CRSP data that team management does not add any positive value for fund performance
(e.g., see Chen, Hong, Huang, and Kubik, 2004; Bar, Kempf, and Ruenzi, 2011).
Columns 5-8 of report the estimation output using MS data. Again columns 1 and 2 show
the estimates for (4U), while columns 3 and 4 for (4C), again without and with fund
86

manager controls, respectively. Now, we see that the results are drastically different. The
coefficient on Team is consistently positive across all estimations and, even though is not
always significant, is also economically sizable at least after accounting for both fund
and manager characteristics. Moreover, at the bottom of the panel we also report the test
results of the hypothesis that slope coefficients on Team in the corresponding MS and
CRSP estimations are the same, Team (MS-CRSP) = 0. As one can see, the difference is
positive and statistically highly significant across all four regression specifications. In
economic terms, this difference is 43-48bp per year, depending on the type of alpha, for
the tests that are based on estimates from regression models with a full set of control
variables.
It is worthwhile to mention the estimation results related to our control variables.
In particular, note that the coefficient estimates and their statistical significance are very
consistent across both CRSP and MS, unlike the results on the Team dummy, and are in
line with results in previous studies. Among fund-level characteristics, we observe that
fund size and expenses have large detrimental effect on performance. These results are
similar to findings in many other papers.29 However, funds benefit when they are part of
a larger family, again consistent with earlier studies (Chen, Hong, Huang and Kubik,
2004; Pollet and Wilson, 2008). We also document persistency in our two risk-adjusted
performance measures. Finally, there is also some evidence (for (4U)) that higher
turnover reduces subsequent returns. As for the manager characteristics, consistent with
Chevalier and Ellison (1999a) we find a positive and highly significant relation between
fund performance metrics and managers SAT scores and no relation to MBA degree. In
addition, our results confirm that fund returns are higher for more experienced managers
with longer tenures at their respective funds (e.g., see Christoffersen and Sarkissian,
29

For the relation between firm size and performance see Chen, Hong, Huang, and Kubik (2004); for the
relation between firm expenses and performance see Jensen (1968), Elton, Gruber, Das, and Hlavka
(1993), Carhart (1997) and others.
87

2009). Note finally that even though the inclusion of manager characteristics drastically
reduces the total number of fund-year observations, the adjusted R2 indicate that they
provide incremental explanatory power for fund returns and therefore are important for
proper decoupling of the team management effect from manager-specific variables.
Panel B of Table 3 shows sub-sample estimations with unconditional Carhart
alpha as the only dependent variable over two non-equal periods, 1992-1999 and 20002010. This non-equal time period split is motivated by some of the well-known earlier
results on the importance of teams for mutual fund returns, such as Chen, Hong, Huang,
and Kubik (2004), who use CRSP data over the 1992-1999 period and do not find any
benefits for team management. Each specification controls for fund and manager
characteristics but, for the sake of convenience, we report only the coefficient on Team
dummy alongside with its respective p-values. The evidence in Panel A that using MS
data leads to significantly more positive impact of team management on fund
performance is present also in sub-sample estimations. The test that slopes on Team for
the respective MS and CRSP regressions are the same, that is, Team (MS-CRSP) = 0, is
rejected for all specifications.
Thus, Table 3 shows that large discrepancies in management structure records
between CRSP and MS databases can translate to significant differences in team
management impact on fund performance. Ceteris paribus, MS data is able to provide
much more support for the benefits of group decision making in the mutual fund
industry.

3.4.3

Additional Misspecification Issues in Management Structure

There are two additional implications of the misspecification in management

structure data in CRSP which are important. First, one can no longer rely on the start
dates of fund manager(s) provided in this database, particularly in cases where more than
88

one fund manager names are listed. The start date (also variable known as mgr_dt) in
CRSP corresponds to a unique fund manager entry and specifies the date the current
manager(s) took control and assumed responsibility of the fund. For entries that list one
fund manager these dates might be less problematic, but for entries that list two or more
fund managers these dates might lead to serious errors. By giving one start date for funds
with two or more fund managers, CRSP leads researchers to assume that these managers
joined the fund on the same date which might not be true in all cases. And this is exactly
what we find in MS data, where in almost all team-managed funds, different fund
managers join the fund on different dates. Second, because CRSP provides incomplete
information on the number of fund managers (as shown previously), one also cannot rely
on the name of fund manager(s) provided in this dataset. Particularly, studies on manager
turnover which use fund manager names from CRSP might be affected from this
misspecification.

3.5

Team Management and Fund Performance: Empirical Tests

Having established that a researcher, using MS data, is more likely to find

evidence of positive contribution of team work in fund management industry, we now

directly examine the extent of its impact by using our full MS sample. Note that the
sample that we use for the reminder of the paper is larger than the one used in the CRSPMS matching tests in Table 3. Our goal is to analyze the potential benefits of team
management for various fund and/or manager characteristics.

3.5.1

The Average Effect of Team Management

Table 4 reports the results of the tests on the impact on team management on our

three measures of fund performance, OAR, (4U) and (4C). We report test results with
89

net (expense-adjusted) returns in Panel A and gross (expense-unadjusted) returns in

Panel B. As in Table 3, all regression specifications include time and investment
objective fixed effects, and the standard errors are clustered by fund. We also indicate the
number of observations and the adjusted R2. Again, the variable of interest is the Team
dummy. Most of our controls are also similar to those in Table 3 with two exceptions.
First, given some controversy regarding the inclusion of lagged dependent variable in
panel tests, we no longer consider lagged performance measures as additional
independent variables.30 Second, given the evidence of funds returns may be different
across geographic locations (e.g., Coval and Moskowitz, 2001; Christoffersen and
Sarkissian, 2009), now include a dummy variable for financial centers (FC) which equals
one if the fund is in a financial center and zero otherwise.
In columns 1-3 of Table 4, the dependent variable is the objective-adjusted
returns. We report the results without and with fund-level and manager-level controls. In
Panel A, the Team dummy comes up positive in all three regressions and is significant at
the 10% level in the most comprehensive specification that controls for both fund and
manager characteristics. In this latter regression, the economic impact of team
management on objective-adjusted fund returns is close to 40bp per year. In columns 4-6,
the dependent variable is the four-factor alpha. In this case, in Panel A even without
controls, the impact of team management is positive and significant at the 5% level. After
adding fund-level variables, its significance drops slightly to 10%, but with the inclusion
of manager characteristics, the coefficient on Team becomes significant at the 5% level,
and its economic magnitude increases by about 50% relative to that in column 4. In
columns 7-9, the dependent variable is conditional alpha. In Panel A, the coefficient on
Team again is positive in all three specifications, and while it is a bit less significant in
the first two regressions relative to the corresponding output in columns 4 and 5, it is
30

See Maddala and Rao (1973) and Grubb and Symons (1987) among others.
90

again significant at the 5% level for the most comprehensive last regression specification.
In fact, the economic impact of team management on conditional alpha after accounting
for all fund and manager characteristics is 46bp per year. The slopes on most of the
control variables in line with those reported in Table 3.31 In Panel B of Table 4, we
generally see the same pattern as in Panel A. There is only a small reduction in economic
and statistical significance of the coefficient on Team dummy for each estimation vis-vis the corresponding test in Panel A. As before, the impact of team management on fund
performance is the largest after controlling for both fund-level and manager
characteristics.
We have observed that on average funds with team management practices appear
to do better than single-managed funds. The next natural inquiry is to determine whether
teams benefit all type of funds, irrespective of their investment objective. If team-induced
performance gains are concentrated in a specific fund category, then the most likely
explanation for previous findings will be not so much related to the benefits that teams
brings to fund operations but rather to the characteristics of that single fund category.
Table 5 reports the results of our tests on the impact on team management separately for
each of the four fund investment objectives. We show the outcome of tests for two riskadjusted measures of fund performance, (4U) and (4C), and report the same set of
estimates as in Table 4. The characteristics of regression models are also the same as
before but they always include both fund- and manager-level controls.
Columns 1 and 2 of Table 5 show that team management virtually has no impact
on aggressive growth funds returns. This could be due to the fact that aggressive growth
funds are believed to be benefitting the most among other fund types from higher
turnover rates; therefore, coordinating frequent trading decisions among multiple team
31

Note that the primary difference in the statistical significance of Team dummy between Table 4 and
Table 3 comes from the increased sample size (e.g., more than 6% in tests with all control variables) rather
than small changes in the set of control variables.
91

members may become impeding for fund performance. Note also that aggressive growth
funds deal with more soft, not easily available information about stocks and, as Stein
(2002) argued, in these cases, single-manager structures may be preferable. This is not
however the case for other objective categories. As shown in columns 3-8, managerial
teams have economically and statistically significant, at least at 10% level, relation to
risk-adjusted returns in all six estimations but one, for (4U) of growth funds.32 Even in
this case, the economic impact of team management is 37bp per year, while that for
growth & income and equity income funds approaches a whapping 1.00% per year.
Therefore, Table 5 illustrates that having funds managed by teams of managers benefits
most of fund categories.

3.5.2 The Effect of an Additional Team Member

Our previous analysis shows that on average team-managed funds perform better
than single-managed funds, and this result holds across most of fund investment
objectives. Clearly, another relevant question is whether the positive relation between
team management and fund returns is linear in team size. Prior research is very scarce on
this issue. One evidence of non-linear benefits of team size is present in Hamilton,
Nickerson, and Owan (2003), who find largest increases in productivity of garment
industry workers when they join the teams at the early stages of team formation. In an
experimental study, Laughlin, Hatch, Silver, and Boh (2006) find that when dealing with
highly intellective problems three-person groups are necessary and sufficient to perform
better than the best individuals, and that groups with more members do not add extra
performance gains.

32

Note that some drop in the statistical significance of Team dummy for growth and equity income funds
simply occurs because of the reduction in sample size rather than from the decrease in the magnitude of
coefficients from the full-sample estimation in Table 4.
92

Recall from our Table 1 (Panel B) that team size indeed appears to be important
to fund returns, and that the largest gains in risk-adjusted performance are observed
among funds administered by three managers. What is necessary to do now is to examine
if this pattern persists or changes after controlling for our usual sets of fund and manager
characteristics. Therefore, we run the following regression model:

Perf i ,t = c 0 + c1 2 FM i ,t + c 2 3FM i ,t + c 3 4 FM i ,t + c 4 5FM i ,t +

1 Fund _ Controlsi ,t 1 + 2 Mgr _ Controlsi ,t + 3 FEi ,t + ei ,t

(4)

where 2FMi,t, is a dummy which equals one if the fund has two fund managers at the end
of calendar year and zero otherwise; 3FMi,t, is a dummy which equals one if the fund has
three fund managers at the end of calendar year and zero otherwise; 4FMi,t is a dummy
which equals one if the fund has four fund managers at the end of calendar year and zero
otherwise; and 5FMi,t is a dummy which equals one if the fund has five (or more) fund
managers at the end of calendar year and zero otherwise. The other variables are defined
as before.
Table 6 shows the estimation results of fund management team size on the two
measures of risk-adjusted fund performance, (4U), and (4C). Consistent with results
of simple difference tests in Panel B of Table 1, the three-manager funds add the most of
performance gains vis--vis single-managed funds in terms of both unconditional and
conditional alphas. The economic value of a three-person team management on fund
performance ranges between 50bp and 60bp per year for the specification that includes
all control characteristics (0.04 and 0.05 percent per month, respectively). Teams with
two managers as well as larger teams (four and five or more managers) add less
performance gains relative to single-managed funds. These extra benefits are not always
statistically significant even at the 10% level which is achieved only among funds with
five or more managers. However, note that not only statistical significance of funds
93

managed by five people but also their economic impact decreases with the inclusion of
control variables, especially after accounting for average manager characteristics. Having
said that, the economic value of team management for funds that are managed by two,
four, or five or more managers can still remain sizable, although always less than that for
funds managed by three people in each respective tests specification. For instance, for
funds with five or more managers the annual impact of team management on their
conditional alpha is 43bp, as reported in column 6 (it is 60bp for three-manager funds).
Thus, Table 6 confirms our prediction P1 and shows that team size is non-linearly
related to fund performance. Intuitively, the number of team members determines the
tradeoff associated with larger knowledge base that more people bring to the team versus
coordination costs among multiple individuals, as indicated by Mueller (2012) and
others. This result is also consistent with Hamilton, Nickerson, and Owan (2003). Each
group member brings his/her specific skills and talents, but large cohorts of people with
various views on the subject matter may reduce productivity due to higher difficulty of
arriving to unanimous conclusions.

3.5.3

Team Management and Geographic Location

If teams in the financial industry are able to achieve diversification of style and

judgment, as argued by Sharpe (1981), then the value of having a team must be more
profound under those conditions when there are more objective reasons for people in
groups to have uncorrelated to each other views. This can occur more easily in larger
cities than in smaller communities. Indeed, group members in larger cities may have
more independent sources of information and more diverse networking potential than
residents of small towns. Therefore, we test this idea by examining now the team impact

94

on fund performance in financial centers versus smaller towns. The regression model is
as follows,

Perf i ,t = c 0 + c1Teami ,t + c 2Teami ,t FCi + c3 FCi +

1 Fund _ Controlsi ,t 1 + 2 Mgr _ Controlsi ,t + 3 FEi ,t + ei ,t

(5)

where Teami,t FCi is the interaction term between the dummies on team management
and financial center dummies.
Table 7 reports the estimation results of fund management team size on our two
risk-adjusted measures of fund performance, (4U), and (4C). Besides reporting the
usual outcome of estimations, for each regression it also shows the results of the F-test of
the hypothesis that the performance of team-managed and single-managed funds is the
same. These tests are conducted separately across funds whose advisors are located in six
financial centers and those outside that set of cities. Columns 1, 2, and 3 of the table
show the estimation results for the unconditional alpha without controls, with fund
controls only, and with full set of control variables, respectively. We can see that in all
three specifications, the coefficient on Team is statistically zero (sometimes positive,
sometimes negative), implying that teams add no gains to performance for funds not
located in financial centers. The F-test at the bottom of the table restates these results.
However, the value of a team is diametrically opposite in financial centers. First, the
coefficient on the interaction term is consistently positive and economically significant,
indicating extra benefits of team management in financial centers versus other places.
Second and more importantly, the F-test shows that in financial centers team-managed
funds always significantly (at the 5% level) outperform single managed funds.33

33

In these tests, we test whether the combined coefficient of the team impact on fund performance, c1+c2,
is positive and statistically significant since both Team and FC are dummies and here take the value of
unity.
95

Our estimations with conditional alpha in columns 4-6 of Table 7 lead to the
same findings. Again, we observe no gains to managing funds in teams if the locations of
funds advisors are outside financial centers. When funds are in financial centers, the
evidence of benefits of group-decision making is even higher than before. Both economic
and statistical results are stronger than in the case of unconditional alpha. For instance,
for the regression specification with the full set of control variables (column 6), the
marginal value of multiple manager funds versus single-managed ones is almost 70bp
per year, and this difference is statistically significant at the 1% level. All these findings
confirm our prediction P2.
The results in Table 7 support Sharpe (1981) arguments and provide novel
evidence that group decision making is more beneficial in such environments where
group members are more likely to acquire knowledge and skills and establish business
connections. Clearly, at least in the finance industry in general and mutual fund industry
in particular, this becomes more achievable in financial centers than in smaller cities. Our
evidence also highlights a new example of superior learning and/or knowledge spillover
effects in larger cities as argued by Jacobs (1969), Glaeser (1999) and others.

3.5.4

The Role of Team Diversity

Besides the tradeoff between group and individual decision making and the

determination of the optimal size of a team, the other important question is the potential
effect of group diversity on performance. The literature on diversity in teams has led to
inconclusive results regarding the impact of group composition on their performance (see
Williams and OReilly, 1998; Jehn, Northcraft, and Neale, 1999; Hamilton, Nickerson,
and Owan, 2003; Van Knippenberg and Schippers, 2007). On the positive side, larger
diversity in team members may enhance information processing skills of the group as a
whole; on the negative side significant differences among team members may cause
96

frictions, conflicts of interests, and within-group biases. Most of the aforementioned

studies deal with limited experimental and empirical data.
Our rich mutual fund dataset with various characteristics of fund managers
provides an ideal testing ground for the examination of the effect of group diversity on
fund performance. In particular, we can create diversity proxies across three dimensions
of fund manager characteristics: tenure with the fund, SAT score, and age. As a diversity
measure we use the coefficient of variation. It is the ratio of the standard deviation of a
variable over its mean, and it is a useful statistic for data which can only take nonnegative values (e.g., see Allison, 1978). Thus, our diversity proxies are:
Tenure Diversity i ,t = (Tenure i ,t ) / (Tenure i ,t ) ,

(6)

SAT Diversity i ,t = ( SATi ,t ) / ( SATi ,t ) ,

(7)

MAge Diversity i ,t = ( MAge i ,t ) / ( MAge i ,t ) ,

(8)

where and are the standard deviation and mean of the corresponding manager
characteristic, respectively. The table below reports the summary statistics of these
diversity measures.

Tenure Diversity
SAT Diversity
MAge Diversity

Mean

S.D.

Min

Max

Median

0.6313
0.0990
0.1834

0.3468
0.0574
0.1110

0.0338
0.0022
0.0111

2.0718
0.3735
0.6985

0.6082
0.0945
0.1746

All average and median diversity measures are within 0-1 range. The largest spread in
these measures is observed for the fund tenure diversity, the smallest for SAT score
diversity.

97

Table 8 shows the impact of team diversity on fund performance for funds
located in financial centers and other places. We immediately focus on geographic
breakup of our sample since we already determined a primary impact of team
management on funds located in larger cities. The table reports the estimates from panel
regressions of unconditional and conditional fund alphas on three team diversity
measures defined by Eqs. (6-8), the number of observations, and the adjusted Rsquares.34 Columns 1 to 4 show the results for funds in financial centers, while columns 5
to 8 in other locations. In columns 1 and 3 financial center fund alphas are regressed
only on the three manager diversity measures with no any controls. We observe
significant economic and statistical impact of diversity in SAT scores and manager age
on fund performance, and this relation is negative. This implies that homogeneous teams
in financial centers outperform heterogeneous ones. The diversity in manager tenure does
not appear to play an important role for fund returns. After controlling for the full set of
fund and manager characteristics, including the team size in columns (2) and (4), our
earlier conclusions only strengthen. Now, the values and statistical significance of
coefficients on manager diversity measures based on SAT scores and age increase, while
retaining the negative sign. A one standard deviation (0.06) increase in the SAT score
diversity increases unconditional and conditional alphas by about 50bp and 70bp per
year, respectively, while one standard deviation (0.1) increase in manager age diversity
leads up to 60bp annual performance boost based on conditional alpha. We do not find
any consistent evidence for the importance of diversity in team members among funds
located outside financial centers, illustrating again the irrelevance of team management
for fund performance for these types of funds. The only significant outcome occurs with

34

Note that our sample size now is much lower than in the earlier tests. This drop occurs for the following
two reasons. First, in the current tests we use only team-managed funds. Second, when only one manager
in a team has identifiable characteristic, it is impossible to compute the diversity measure based on this
characteristic. However, these observations still contribute to the sample that contains average manager
characteristics.
98

manager tenure diversity which results in a positive slope when the dependent variable is
conditional alpha after controlling for fund and other manager characteristics.
Thus, our findings support other papers on team diversity that highlight more
problems than benefits associated with grouping people with different characteristics into
the same teams (e.g., Jehn, Northcraft, and Neale, 1999). The results are also consistent
with career concerns issues in mutual funds (e.g., see Chevalier and Ellison, 1999b).
Managers with large differences in incentives and career options, stemming from
differences in their educational background and age, are unlikely to collaborate well on
such vaguely defined issues as fund portfolio composition and trading activity.

3.6

Team Management, Risk Taking, and Fund Characteristics

After analyzing various aspects of performance differences between team-

managed and single-managed funds in the earlier part of the paper, in this section, we
examine whether there exist systematic differences in risk taking and other fund
characteristics that can be distinctly attributed to group decision making in mutual fund
industry. First, recall that the existing literature is unclear on the impact of team on risk
taking. Some studies, such as Wallach and Kogan (1965), Stoner (1968), Sunstein
(2002), and others find that groups could act more aggressively and undertake more risk.
Other studies, however, such as Barry and Starks (1984) and Adams and Ferreira (2009),
provide theoretical and some empirical evidence that groups, may in fact, reduce risk. To
address these issues within our framework, we use the following model:
Risk i ,t = d 0 + d 1Team i ,t + 1 Fund _ Controls i ,t 1 + 2 Mgr _ Controls i ,t + 3 FE i ,t + ei ,t ,

(9)

where Riski,t is one of funds i risk measures at time t. We consider several risk measures.
The first is the total volatility of the fund. The second is market risk and the idiosyncratic
99

residual volatility coming from the standard CAPM. The final set comes from the
Carhart (1997) model (see Eq. (1)) and includes market beta, the loadings on size, bookto-market and momentum portfolios, as well as the idiosyncratic residual volatility from
this model.
Table 9 reports the results of the estimation of the impact of team management on
various risk measures. In this table, the market and residual risk from the CAPM are
denoted by Mrk1 and IdVol1, respectively, while these risks from the Carhart (1997)
model as Mrk4 and IdVol4, respectively. Each regression specification includes a full set
of fund and manager controls as in previous tests with the exception of two fund-level
variables, namely, fund family size and net flows. There are no a priori expectations
about the impact of those two variables have on risk characteristics of funds. We can see
that team management has no statistically significant impact on funds total risk, market
risk, or idiosyncratic risk, irrespective whether the latter two measures are estimated
based on the CAPM or Carhart (1997) model. One could still argue that the total risk of
team managed funds, even though being insignificant statistically, is large in economic
sense, reaching almost 1% per year (0.0797*12). However, the two metrics of the
idiosyncratic risk, IdVol1 and IdVol4, that have different signs as well as economically
similar yet small exposures to the market portfolio, Mrk1 and Mrk4 imply at best
potential exposure to non-conventional risk measures. Indeed, we observe that teammanaged funds load more on small firms and high book-to-market firms: the coefficients
on SMB and HML are both positive and significant. Among control variables, the most
consistent results for market risk are that we find that it increases for large funds and
funds with higher turnover rates. Also, we note that fund age has negative and almost
everywhere statistically significant impact on risk across most of its measures except
momentum.

100

In sum, Table 9 illustrates that the impact of group-decision making on fund risk
taking behavior is not very straightforward. Team-managed funds do not seem to take
more market risk, and their volatility, both total and risk-adjusted, is also non-excessive,
but they may expose themselves more to other possible measures of risk than singlemanaged funds.
Next, we look if team management is associated with specific fund characteristics
using the regression setting below:
FundChar i ,t = d 0 + d 1Team i ,t + 1 Fund _ Controls i ,t 1 + 2 Mgr _ Controls i ,t + 3 FE i ,t + ei ,t ,

(10)
where FundChari,t is one of funds i characteristics at time t. Four fund characteristics are
relevant for our analysis: Expenses, turnover, fund size and net flows. Clearly, in these
regression models, our set of fund-level control variables must depend on the fund
characteristic in question.
Table 10 reports the results of tests based on Eq. (10). The table has 12 columns,
three regression specifications per each fund characteristic. Columns 1-2 show the results
for fund expenses. Consistent with Table 1 data, we find that team-managed funds are
generally cheaper for investors. This result is significant with fund-level controls but,
with the sample reduction after the addition of manager-level controls, drops to
insignificance. Columns 3-4 show the results for fund turnover. We observe that team
management drastically reduces the trading frequency of funds and this drop is
statistically significant. For instance, in economic terms, an average team-managed fund
reduces annual turnover by 12.4% relative to a single-managed fund with similar fund
and manager characteristics. Columns 5-6 show the results for fund size. A priori, one
can think that larger funds are more likely to have teams of portfolio managers. However,

101

just like Table 1 provides no clear signs that multiple-manager funds are usually larger,
the estimation results in the current table that account for control variables also give no
convincing support for any relation between team management and fund size.35 Finally,
in columns 7-8, we show the impact of teams on generating fund flows. In these tests, we
follow Sirri and Tufano (1998) and, besides controlling for the standard set of fund
characteristics, also the lagged unconditional alpha, (4U)i,t-1, and the lagged flows to
funds with the same investment objective, Obj Flowsi,t-1. We find that team-managed
funds are able to generate significantly higher net flows to their respective funds. This
statistically significant result becomes even stronger after the incorporation of managerial
controls in the last column of the table. Our finding that team-managed funds increase
fund flows is also consistent with recent trend of the increase in the proportion of
multiple-manager funds.

3.7

Conclusions
In this paper, we revisit the question on the benefits of collective versus

individual decision making. Few studies exist in economics literature that estimate the
impact of a team on worker productivity and risk taking in rather indirect ways basing
their findings on relatively limited data. Using detailed managerial-level data from
mutual funds allows one to directly observe any differences in various aspects of
performance and risk preferences between single-managed and team-managed funds.
However, prior research in this area has been largely relying on CRSP dataset and the
prevailing conclusion has been multiple-manager funds perform no better if not worse
than solo-manager ones.

35

Our set of fund-level control variables also include lagged fund size as in Chevalier and Ellison (1999a).
102

We use mutual fund data from Morningstar and first meticulously show that there
exist large discrepancies in managerial structure reporting between this database and
CRSP. This misspecification averages about 20% per year over our sample period of
1992-2010. More importantly, using more reliable Morningstar data we provide
compelling evidence that team management has on average a positive impact on fund
risk-adjusted returns across all fund investment objectives except aggressive growth. In
these tests, we are able to control for a range of fund-level and manager-specific
characteristics.
We further show that the influence of a group decision making on fund
performance is non-linear in team size and is not uniform across all geographic locations.
Funds benefit the most from a team work of three portfolio managers. This may indicate
the potential trade-off between the benefits of collective wisdom and increasing
coordination and/or free-rider issues that become more problematic in larger groups.
Also, the benefits of team management are strongly present among funds in financial
centers but not outside those locations. This outcome is consistent with the idea that
larger cities provide wider opportunities for learning and knowledge spillovers, so the
potential contribution of each manager to fund activities in larger cities is higher than in
smaller towns. We observe that team management practice in financial centers is
effective among funds with more homogeneous managers along education and age
dimensions, possibly reflecting the benefits of more alignment in career concerns.
Finally, we show that among other benefits of team-managed funds are substantially
lower turnover and ability to attract new money flows into their funds.

103

Table 1
Summary statistics of mutual funds management structure
Panel A: Distribution of single and team-managed funds
1 Manager
2 Managers
3 Managers
4 Managers
5+ Managers
Number Percent Number Percent Number Percent Number Percent Number Percent
17
2
29
4
1992
519
67
145
19
70
9
20
2
39
4
1993
584
63
202
22
78
8
23
2
35
3
1994
672
64
243
23
85
8
30
3
45
4
1995
729
61
273
23
115
10
57
4
46
4
1996
767
57
350
26
121
9
63
4
48
3
1997
859
56
399
26
161
11
67
4
84
5
1998
921
53
449
26
210
12
81
5
99
6
1999
961
51
494
26
258
14
90
5
116
6
2000
987
49
587
29
253
12
115
6
134
7
2001
1004
47
602
28
272
13
120
6
137
7
2002
1000
46
647
30
283
13
145
7
161
8
2003
971
44
662
30
287
13
174
9
196
10
2004
876
39
659
30
320
14
226
11
300
14
2005
832
35
698
29
335
14
222
11
346
16
2006
802
33
731
30
352
14
247
12
333
16
2007
776
31
748
30
363
15
243
12
327
16
2008
776
32
732
30
356
15
189
9
315
16
2009
719
31
691
30
392
17
164
9
293
16
2010
622
29
666
31
398
19
15377
43
9978
28
4709
13
2293
7
3083
10
Total
Panel B: Fund performance of single and team-managed funds
1 Manager
2 Managers
3 Managers
Mean
S.D.
Mean
S.D.
Mean
S.D.
OAR
0.001
1.347
0.015
1.283
0.018
1.157
Diff
0.014
0.017
p-value
(0.447)
(0.470)
(4U)
-0.042
0.796
-0.031
0.765
-0.006
0.738
Diff
0.011
0.036**
p-value
(0.342)
(0.017)
(4C)
-0.006
0.857
-0.003
0.822
0.033
0.793
Diff
0.003
0.039**
p-value
(0.806)
(0.016)

104

4 Managers
Mean
S.D.
0.048
1.480
0.047
(0.147)
-0.029
0.788
0.013
(0.528)
0.009
0.866
0.015
(0.498)

5+ Managers
Mean
S.D.
0.037
0.975
0.036
(0.176)
-0.005
0.603
0.037**
(0.031)
0.018
0.659
0.024
(0.188)

Table 1 (continued)
Panel C: Fund characteristics of single and team-managed funds
1 Manager

2 Managers

3 Managers

4 Managers

5+ Managers

Mean

S.D.

Mean

S.D.

Mean

S.D.

Mean

S.D.

Mean

S.D.

4.728

2.567

4.820

2.647

4.981

2.638

4.756

2.701

4.715

2.262

914

3,800

667

2,030

864

2,690

941

3,450

2,310

10,300

Fund Age

10.240

12.569

10.208

12.185

10.201

12.209

9.193

10.514

10.615

11.446

Turnover

0.913

0.843

0.856

0.698

0.906

0.745

0.828

0.630

0.807

0.627

Expenses

1.316

0.475

1.292

0.437

1.270

0.424

1.244

0.410

1.178

0.407

Volatility
TNA

Panel D: Fund manager characteristics of single and team-managed funds

1 Manager

Tenure
SAT

2 Managers

3 Managers

4 Managers

5+ Managers

Mean

S.D.

Mean

S.D.

Mean

S.D.

Mean

S.D.

Mean

S.D.

4.42

4.80

3.83

3.60

3.67

3.20

3.52

3.2

3.61

2.9

116.13

1143.16

99.95

1139.86

93.01

1145.23

79.91

0.70

0.46

0.80

0.40

0.87

0.34

0.95

0.23

44.99

8.83

44.34

8.53

44.32

8.53

44.48

7.09

1157.44

MBA

0.53

Mage

45.90

139.12
0.50
9.56

1146.17

This table gives the summary statistics of domestic equity mutual funds in the United States from 1992 to
2010. Panel A reports the number (and percentage) of funds managed by one, two, three, four, and five (or
more) fund managers each year. Panel B report the mean and standard deviation of three fund performance
measures. OAR (%, per month) is investment objective adjusted fund return, which is the difference
between the average monthly net fund return for fund i in year t and the average monthly fund return of all
funds in the matched investment objective in year t. (4U) and (4C) are the monthly risk-adjusted net
fund returns using unconditional and conditional versions of Carhart (1997) four-factor model,
respectively. The panel also shows the difference in performance test results between each group of teammanaged funds and single-managed funds. Panel C reports the mean and standard deviation of different
fund characteristics over the entire sample period. Volatility (%) is the standard deviation of monthly fund
returns over the past 12 months for fund i in year t. TNA ($, millions) is the total net asset under
management of fund i in year t. Fund Age (years) is the difference between fund is inception year and the
current year t. Turnover is the minimum of aggregated sales or aggregated purchases of securities of the
year divided by the average 12-month total net assets of the fund. Expenses (%) is the annual total expense
ratio of the fund i in year t. Panel D reports fund manager characteristics following Chevalier and Ellison
(1999). Tenure (years) is the number of years the fund manager remains with the fund i at time t. SAT is
the SAT score of matriculates of the fund managers undergraduate institution. MBA is defined as a
dummy variable which equals one when a fund manager (or at least one of the team members) has MBA
degree and zero otherwise. MAge (years) is the fund managers age at current year t. Important note: In
case of teams, we simply take the average for each of these characteristics: Tenure, SAT and MAge.

105

Year
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

Table 2
Misspecification in management structure: CRSP versus Morningstar
Misspecification
CRSP
Morningstar
Single(CRSP) - Team(MS) Team(CRSP) - Single(MS)
Matched
# Funds % Single % Team % Single % Team # Funds % Single(CRSP) # Funds % Team(CRSP)
582
80.76
19.24
67.87
32.13
89
18.94
14
12.50
720
81.94
18.06
64.58
35.42
147
24.92
22
16.92
835
79.64
20.36
63.35
36.65
176
26.47
40
23.53
946
78.22
21.78
61.42
38.58
196
26.49
37
17.96
69.04
30.96
58.17
41.83
173
24.09
60
18.63
1040
1238
63.25
36.75
56.54
43.46
166
21.20
83
18.24
60.90
39.10
54.17
45.83
222
23.37
117
19.18
1560
1668
54.02
45.98
50.84
49.16
177
19.64
124
16.17
1678
52.26
47.74
48.63
51.37
197
22.46
136
16.98
1798
50.17
49.83
47.94
52.06
183
20.29
143
15.96
1864
47.64
52.36
46.51
53.49
190
21.40
169
17.32
1933
42.42
57.58
44.28
55.72
145
17.68
181
16.26
1940
33.04
66.96
40.21
59.79
116
18.10
255
19.63
2015
33.20
66.80
35.33
64.67
184
27.50
227
16.86
2068
33.70
66.30
33.46
66.54
203
29.12
198
14.44
2129
31.38
68.62
31.75
68.25
122
18.26
130
8.90
2110
30.19
69.81
32.65
67.35
122
19.15
174
11.81
1928
30.39
69.61
31.64
68.36
116
19.80
140
10.43
1866
30.98
69.02
29.80
70.20
105
18.17
83
6.44

# Misspecified
Funds
103
169
216
233
233
249
339
301
333
326
359
326
371
411
401
252
296
256
188

% Matched
Sample
17.70
23.47
25.87
24.63
22.40
20.11
21.73
18.05
19.85
18.13
19.26
16.86
19.12
20.40
19.39
11.84
14.03
13.28
10.08

This table describes the nature and extent of misspecification in the management structure of the U.S. domestic equity mutual funds from 1992 to 2010. Using a
matched sample of mutual funds in the CRSP and Morningstar (MS) mutual fund database, the first columns in the table report the percentage of mutual funds
classified as reporting one manager name (Single-managed), reporting two or more manager names (Team-managed) in both databases by year. In both cases the
unit of observation is the mutual fund, not the fund share class. Columns seven to twelve report the extent of management structure misspecification in the
matched sample by year. Column seven reports the number of funds that are classified as single-managed in CRSP but are team-managed in MS in the same
calendar year. Column eight reports these misspecified funds as a percentage of all funds classified as single-managed in CRSP. Similarly, column nine reports
the number of funds that are identified as team-managed in CRSP but are single-managed in MS. Column ten reports these misspecified funds as a percentage of
all funds classified as team-managed in CRSP. Columns eleven and twelve report the total number of misspecified funds and express it as a percentage of total
matched sample each year.

106

Table 3
Effect on team management on fund performance: CRSP versus Morningstar
Panel A: Full matched sample analysis

Team
Fund Sizei,t-1
Fund Agei,t
Family Sizei,t-1
Expensesi,t-1
Turnoveri,t-1
Flowsi,t-1
Performancei,t-1
Tenurei,t
SATi,t
MBAi,t
MAgei,t
Constant
Time & Obj. FE
Cluster (Fund)
R2 (%)
Obs.
Team (MS-CRSP) = 0
p-value

CRSP
(4U)
(4U)
(4C)
(4C)
-0.0012 -0.0108 -0.0033 -0.0058
(0.912) (0.475) (0.777) (0.728)
-0.0270*** -0.0316*** -0.0260*** -0.0243***
(0.000) (0.000) (0.000) (0.000)
-0.0035 -0.0166* -0.0092 -0.0304***
(0.629) (0.076) (0.244) (0.003)
0.0122*** 0.0128*** 0.0125*** 0.0085**
(0.000) (0.001) (0.000) (0.049)
-0.0573*** -0.0585*** -0.0457*** -0.0472**
(0.000) (0.002) (0.005) (0.022)
-0.0271*** -0.0224* -0.0050 0.0137
(0.003) (0.078) (0.622) (0.334)
-0.0043 -0.0026 -0.0057* -0.0057
(0.150) (0.468) (0.075) (0.126)
0.0948*** 0.1027*** 0.0782*** 0.0809***
(0.000) (0.000) (0.000) (0.000)
0.0038**
0.0044**
(0.022)
(0.013)
0.0220***
0.0196***
(0.000)
(0.002)
0.0093
-0.0021
(0.587)
(0.917)
-0.0838**
-0.1010**
(0.038)
(0.017)
0.1668** 0.3841** 0.1248
0.4854**
(0.025) (0.033) (0.132) (0.014)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
12.65
13.33
12.76
13.31
18,437
10,982
18,437
10,982

107

Morningstar
(4U)
(4U)
(4C)
(4C)
0.0134
0.0247
0.0127
0.0340**
(0.204) (0.106) (0.266) (0.039)
-0.0272*** -0.0321*** -0.0262*** -0.0248***
(0.000) (0.000) (0.000) (0.000)
-0.0031 -0.0175* -0.0087 -0.0316***
(0.672) (0.061) (0.269) (0.002)
0.0123*** 0.0134*** 0.0126*** 0.0092**
(0.000) (0.001) (0.000) (0.032)
-0.0568*** -0.0571*** -0.0451*** -0.0455**
(0.000) (0.003) (0.006) (0.027)
-0.0268*** -0.0212* -0.0047 0.0153
(0.003) (0.097) (0.644) (0.280)
-0.0043 -0.0026 -0.0057* -0.0057
(0.153) (0.464) (0.077) (0.123)
0.0948*** 0.1025*** 0.0782*** 0.0805***
(0.000) (0.000) (0.000) (0.000)
0.0045***
0.0052***
(0.007)
(0.003)
0.0230***
0.0208***
(0.000)
(0.001)
0.0015
-0.0112
(0.928)
(0.571)
-0.0789*
-0.0952**
(0.051)
(0.025)
0.1611** 0.3366* 0.1189
0.4286**
(0.032) (0.065) (0.153) (0.031)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
12.66
13.35
12.76
13.34
18,437
10,982
18,437
10,982
0.0146*** 0.0355*** 0.0160*** 0.0398***
(0.000) (0.000) (0.000) (0.000)

Table 3 (continued)
Panel B: Sub-period analysis with (4U) as the dependent variable
CRSP
Team
Fund Controls
Mgr. Controls
Constant
Time & Obj. FE
Cluster (Fund)
R2 (%)
Obs.
Team (MS-CRSP) = 0
p-value

1992-1999
-0.0020 0.0213
(0.941) (0.515)
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
5.42
5.66
3,626
2,618

2000-2010
0.0015 -0.0165
(0.892) (0.314)
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
15.13
16.37
14,811
8,364

Morningstar

1992-1999
0.0215
0.0520*
(0.400)
(0.086)
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
5.43
5.74
3,626
2,618
0.0235*** 0.0307***
(0.000) (0.000)

2000-2010
0.0122
0.0153
(0.298)
(0.402)
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
15.14
16.37
14,811
8,364
0.0107*** 0.0319***
(0.000) (0.000)

This table compares the effect of management structure on fund performance across CRSP and Morningstar
databases using a panel regression approach on matched sample from 1992 to 2010. Panel A reports regression
estimates of the matched funds across full sample period using both databases, while Panel B reports regression
estimates of the matched funds across two sub-periods. In Panel A, the dependent variable includes two performance
measures, (4U) and (4C), which are the monthly risk-adjusted net fund returns using unconditional and
conditional versions of Carhart (1997) four-factor model, respectively. In Panel B the dependent variable is (4U).
The independent variable of interest is Team, defined as a dummy variable which equals one if the fund has two (or
more) fund managers and zero if it has only one fund manager at the end of calendar year. Other independent
variables include various fund and manager characteristics as controls. Fund Size is the log of total net assets under
management of the fund. Fund Age is the log of the difference between the funds inception year and the current
year. Family Size is the log of total net asset under management of the funds family. Expenses is the annual total
expense ratio of the fund. Turnover is the minimum of aggregated sales or aggregated purchases of securities of the
year divided by the average 12-month total net assets of the fund. Flows is the net growth in total net assets under
management of the fund over the past year. Performance is the corresponding lagged fund performance measure,
(4U) or (4C). Tenure is the number of years the fund manager remains with the fund. SAT is the SAT score
(divided by 100) of matriculates of the fund managers undergraduate institution. MBA is defined as a dummy
variable which equals one when a fund manager (or at least one of the team members) has MBA degree and zero
otherwise. Manager Age is the log of fund managers age in current year. All regression specifications include time
and investment objective fixed effects (FE), and the standard errors are clustered by fund. Each regression model
also reports the p-values of coefficients, the number of observations and the adjusted R2. Team (MS-CRSP) is the
hypothesis that slope coefficients on Team in the corresponding Morningstar and CRSP estimations are the same
and p-value is the p-value of this test. ***, ** and * indicate significance at the 1%, 5%, and 10% levels, respectively.

108

Table 4
Effect of team management of fund performance
Panel A: Tests with net (expense-adjusted) returns
OAR
(1)
Teami,t

0.0237
(0.154)

Fund Sizei,t-1
Fund Agei,t
Family Sizei,t-1
Expensesi,t-1
Turnoveri,t-1
Volatilityi,t-1
Flowsi,t-1
FCi

(2)
0.0128
(0.332)
-0.0384***
(0.000)
0.0048
(0.631)
0.0126***
(0.000)
-0.0214
(0.311)
0.0377***
(0.005)
-0.0307**
(0.017)
-0.0025
(0.411)
0.0110
(0.378)

Tenurei,t
SATi,t
MBAi,t
MAgei,t
Constant

0.0098
(0.751)
Time & Obj. FE Yes
Cluster (Fund) Yes
-0.04
R2 (%)
31,440
Obs.

0.5517***
(0.000)
Yes
Yes
1.93
20,565

(3)
*

0.0308
(0.094)
-0.0555***
(0.000)
-0.0048
(0.696)
0.0208***
(0.000)
-0.0462*
(0.056)
0.0372**
(0.031)
-0.0063
(0.786)
-0.0057
(0.169)
-0.0007
(0.965)
0.0078***
(0.001)
0.0321***
(0.000)
0.0293
(0.174)
-0.0017
(0.971)
0.2223
(0.296)
Yes
Yes
2.99
12,135

(4U)
(4)
**

(5)
*

0.0216
(0.031)

0.0181
(0.100)
-0.0211***
(0.000)
-0.0138*
(0.080)
0.0104***
(0.000)
-0.0414**
(0.011)
-0.0279***
(0.004)
-0.0112**
(0.033)
-0.0001
(0.974)
-0.0047
(0.663)

-0.0556**
(0.049)
Yes
Yes
11.02
26,703

0.1569**
(0.044)
Yes
Yes
11.90
19,781

109

(4C)
(6)
**

0.0320
(0.043)
-0.0253***
(0.000)
-0.0284***
(0.004)
0.0110***
(0.005)
-0.0532***
(0.007)
-0.0241*
(0.072)
-0.0068
(0.339)
0.0008
(0.818)
-0.0079
(0.571)
0.0060***
(0.001)
0.0212***
(0.001)
0.0005
(0.979)
-0.1032**
(0.012)
0.4361**
(0.019)
Yes
Yes
12.77
11,646

(7)

(8)

(9)

0.0189
(0.081)

0.0184
(0.118)
-0.0225***
(0.000)
-0.0142*
(0.093)
0.0106***
(0.001)
-0.0369**
(0.041)
-0.0196*
(0.069)
0.0235***
(0.000)
-0.0027
(0.346)
-0.0051
(0.663)

-0.0996***
(0.001)
Yes
Yes
11.09
26,703

0.0213
(0.801)
Yes
Yes
12.31
19,781

0.0381**
(0.025)
-0.0211***
(0.000)
-0.0382***
(0.000)
0.0080*
(0.060)
-0.0472**
(0.028)
-0.0046
(0.746)
0.0261***
(0.000)
-0.0033
(0.356)
0.0104
(0.491)
0.0071***
(0.000)
0.0188***
(0.005)
-0.0091
(0.645)
-0.1310***
(0.002)
0.4687**
(0.019)
Yes
Yes
13.25
11,646

Panel B: Tests with gross (expense-unadjusted) returns

OAR
(1)
0.0179
(0.273)
Fund Controls
No
Mgr. Controls
No
Constant
Yes
Yes
Time & Obj. FE
Yes
Cluster (Fund)
-0.05
R2 (%)
31,440
Obs.
Teami,t

(2)
0.0091
(0.482)
Yes
No
Yes
Yes
Yes
2.16
20,565

(3)
0.0288
(0.112)
Yes
Yes
Yes
Yes
Yes
3.22
12,135

(4)
0.0172*
(0.082)
No
No
Yes
Yes
Yes
10.86
26,703

(4U)
(5)
0.0159
(0.142)
Yes
No
Yes
Yes
Yes
11.91
19,781

(6)
0.0302*
(0.056)
Yes
Yes
Yes
Yes
Yes
12.82
11,646

(7)
0.0145
(0.177)
No
No
Yes
Yes
Yes
10.97
26,703

(4C)
(8)
0.0163
(0.161)
Yes
No
Yes
Yes
Yes
12.54
19,781

(9)
0.0362**
(0.032)
Yes
Yes
Yes
Yes
Yes
13.49
11,646

This table shows the effect of management structure on fund performance using the Morningstar U.S. domestic
equity mutual fund sample from 1992 to 2010. It reports the estimates from panel regressions of fund performance
on management structure (team versus single) and other controls. Panel A shows test results with net (expenseadjusted) returns; Panel B with gross (expense-unadjusted) returns. The dependent variable includes three
performance measures: OAR, (4U), and (4C). OAR is the difference between the average monthly net fund
return for the fund in year t and the average monthly net fund returns of all funds in the matched investment
objective in year t. (4U) and (4C) are the monthly risk-adjusted net fund returns using unconditional and
conditional versions of Carhart (1997) four-factor model, respectively. The independent variable of interest is Team,
defined as a dummy variable which equals one if the fund has two (or more) fund managers and zero if the fund has
only one fund manager at the end of calendar year. Other independent variables include various fund and manager
characteristics as controls. Fund Size is the log of total net assets under management of the fund. Fund Age is the log
of the difference between the funds inception year and the current year. Family Size is the log of total net asset
under management of the funds family. Expenses is the annual total expense ratio of the fund. Turnover is the
minimum of aggregated sales or aggregated purchases of securities of the year divided by the average 12-month
total net assets of the fund. Flows is the net growth in total net assets under management of the fund over the past
year. Volatility (%) is the standard deviation of monthly net fund returns over the past 12 months for the fund. FC is
the dummy variable which equals one if the fund is in a financial center and zero otherwise. Financial center funds
have headquarters located within 50 miles of Boston, Chicago, Los Angeles, New York, Philadelphia, or San
Francisco. Tenure is the number of years the fund manager remains with the fund. SAT is the SAT score (divided by
100) of matriculates of the fund managers undergraduate institution. MBA is defined as a dummy variable which
equals one when a fund manager (or at least one of the team members) has MBA degree and zero otherwise. MAge
is the log of fund managers age in current year. All regression specifications include time and investment objective
fixed effects and the standard errors are clustered by fund. Each regression model also reports the p-values of
coefficients, the number of observations and the adjusted R2. ***, ** and * indicate significance at the 1%, 5%, and
10% levels, respectively.

110

Table 5
Effect of team management of fund performance by investment objective

Teami,t
Fund Controls
Mgr. Controls
Constant
Time & Obj. FE
Cluster (Fund)
R2 (%)
Obs.

Aggressive Growth
(4U)
(4C)
-0.0010
-0.0179
(0.981)
(0.696)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
15.23
15.06
2,402
2,402

Growth
(4U)
(4C)
0.0305
0.0388*
(0.151)
(0.082)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
13.84
13.42
6,908
6,908

Growth & Income

(4U)
(4C)
***
0.0736
0.0833***
(0.005)
(0.003)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
15.66
18.00
1,761
1,761

Equity Income
(4C)
(4U)
*
0.0765
0.0804*
(0.050)
(0.051)
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
16.04
18.42
575
575

This table shows the effect of management structure on fund performance using the Morningstar U.S. domestic
equity mutual fund sample from 1992 to 2010. It reports the estimates from panel regressions of fund performance
on management structure (team versus single) and other controls and other controls across four different MS
investment objective categories: Aggressive Growth, Growth, Growth & Income, and Equity Income. The
dependent variable includes two performance measures, (4U), and (4C), which are the monthly risk-adjusted net
fund returns using unconditional and conditional versions of Carhart (1997) four-factor model, respectively. The
independent variable of interest is Team, defined as a dummy variable which equals one if the fund has two (or
more) fund managers and zero if the fund has only one fund manager at the end of calendar year. Other independent
variables include various fund and manager characteristics as controls and are the same as in Table 4. All regression
specifications include time and investment objective fixed effects and the standard errors are clustered by fund. Each
regression model also reports the p-values of coefficients, the number of observations and the adjusted R2. ***, ** and
*
indicate significance at the 1%, 5%, and 10% levels, respectively.

111

Table 6
Effect of team size on fund performance

2 Managers
3 Managers
4 Managers
5+ Managers
Fund Controls
Mgr. Controls
Constant
Time & Obj. FE
Cluster (Fund)
R2 (%)
Obs.

(1)
0.0121
(0.317)
0.0359**
(0.015)
0.0155
(0.516)
0.0305**
(0.043)
No
No
Yes
Yes
Yes
11.13
25,908

(4U)
(2)
0.0124
(0.336)
0.0320**
(0.045)
-0.0068
(0.737)
0.0328*
(0.050)
Yes
No
Yes
Yes
Yes
11.96
19,555

(3)
0.0307*
(0.091)
0.0405*
(0.065)
0.0154
(0.526)
0.0291
(0.184)
Yes
Yes
Yes
Yes
Yes
12.83
11,534

(4)
0.0058
(0.653)
0.0384**
(0.016)
0.0230
(0.373)
0.0236
(0.151)
No
No
Yes
Yes
Yes
11.20
25,908

(4C)
(5)
0.0073
(0.600)
0.0388**
(0.021)
0.0052
(0.802)
0.0307*
(0.093)
Yes
No
Yes
Yes
Yes
12.39
19,555

(6)
0.0304
(0.119)
0.0499**
(0.032)
0.0392
(0.126)
0.0361
(0.123)
Yes
Yes
Yes
Yes
Yes
13.28
11,534

This table shows the effect of team size on fund performance using the Morningstar U.S. domestic equity mutual
fund sample from 1992 to 2010. It reports the estimates from panel regressions of fund performance on team size
and other controls. The dependent variable includes two risk-adjusted performance measures, (4U) and (4C).
(4U) and (4C) are the monthly risk-adjusted net fund returns using unconditional and conditional versions of
Carhart (1997) four-factor model, respectively. 2 Managers is a dummy variable which equals one if the fund has
two fund managers at the end of calendar year and zero otherwise; 3 Managers is a dummy variable which equals
one if the fund has three fund managers at the end of calendar year and zero otherwise; 4 Managers is a dummy
variable which equals one if the fund has four fund managers at the end of calendar year and zero otherwise; 5+
Managers is a dummy variable which equals one if the fund has five (or more) fund managers at the end of calendar
year and zero otherwise. Other independent variables include various fund and manager characteristics as controls
and are the same as in Table 4. All regression specifications include time and investment objective fixed effects and
the standard errors are clustered by fund. Each regression model also reports the p-values of coefficients, the number
of observations and the adjusted R2. ***, ** and * indicate significance at the 1%, 5%, and 10% levels, respectively.

112

Table 7
Interaction of team and location on fund performance

Teami,t
Teami,t

FCi

FCi
Fund Controls
Mgr. Controls
Constant
Time & Obj. FE
Cluster (Fund)
R2 (%)
Obs.
F-test: FC (Team - Single)
p-value
F-test: NFC(Team - Single)
p-value

(1)
0.0095
(0.572)
0.0222
(0.286)
-0.0124
(0.459)
No
No
Yes
Yes
Yes
11.29
24,714
0.0317**
(0.013)
0.0095
(0.572)

(4U)
(2)
-0.0052
(0.774)
0.0400*
(0.076)
-0.0290
(0.127)
Yes
No
Yes
Yes
Yes
11.91
19,781
0.0348**
(0.011)
-0.0052
(0.774)

(3)
0.0144
(0.551)
0.0290
(0.326)
-0.0278
(0.284)
Yes
Yes
Yes
Yes
Yes
12.77
11,646
0.0434**
(0.026)
0.0144
(0.551)

(4)
-0.0089
(0.612)
0.0469**
(0.033)
-0.0267
(0.129)
No
No
Yes
Yes
Yes
11.33
24,714
0.0380***
(0.007)
-0.0089
(0.612)

(4C)
(5)
-0.0152
(0.417)
0.0578**
(0.016)
-0.0401**
(0.046)
Yes
No
Yes
Yes
Yes
12.34
19,781
0.0426***
(0.004)
-0.0152
(0.417)

(6)
0.0092
(0.725)
0.0475
(0.138)
-0.0223
(0.431)
Yes
Yes
Yes
Yes
Yes
13.26
11,646
0.0567***
(0.007)
0.0092
(0.725)

This table shows the impact of management structure and fund location interaction has on fund performance using
the Morningstar U.S. domestic equity mutual fund sample from 1992 to 2010. It reports the estimates from panel
regressions of fund performance on Team and Financial Center location and other controls. The dependent variable
includes two performance measures, (4U) and (4C), which are the monthly risk-adjusted net fund returns using
unconditional and conditional versions of Carhart (1997) four-factor model, respectively. Independent variables of
interest are Team FC, Team, and FC, where Team is defined as a dummy variable which equals one if the fund has
two (or more) fund managers and zero otherwise, while FC is a dummy variable which equals one if the fund is
located in a financial center and zero otherwise. Financial center funds have their advisors located within 50 miles of
Boston, Chicago, Los Angeles, New York, Philadelphia, or San Francisco. Other independent variables are defined
as in Table 4. All regression specifications include time and investment objective fixed effects and the standard
errors are clustered by fund. Each regression model also reports the p-values of coefficients, the number of
observations and the adjusted R2. ***, ** and * indicate significance at the 1%, 5%, and 10% levels, respectively.

113

Table 8
Effect of team diversity on fund performance across geographic locations

Tenure Diversityi,t
SAT Diversityi,t
MAge Diversityi,t
Team Sizei,t
Fund Controls
Mgr. Controls
Constant
Time & Obj. FE
Cluster (Fund)
R2 (%)
Obs.

Financial Centers
(4U)
(4C)
(1)
(2)
(3)
(4)
-0.0290
0.0093
-0.0657
-0.0229
(0.515)
(0.838)
(0.167)
(0.643)
-0.6243** -0.6434** -0.8084*** -1.0662***
(0.032)
(0.019)
(0.007)
(0.000)
-0.4225** -0.3695** -0.5429*** -0.4976***
(0.027)
(0.047)
(0.002)
(0.003)
0.0047
0.0193
(0.815)
(0.377)
No
Yes
No
Yes
No
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
15.14%
16.59%
17.40%
18.35%
1,924
1,667
1,924
1,667

Non-Financial Centers
(4U)
(4C)
(5)
(6)
(7)
(8)
0.0351
0.0772
0.0805
0.1225**
(0.499)
(0.166)
(0.155)
(0.049)
0.0325
0.0066
-0.0126
-0.0395
(0.938)
(0.988)
(0.977)
(0.933)
0.2100
0.2642
0.1042
0.1605
(0.202)
(0.110)
(0.552)
(0.353)
-0.0488**
-0.0235
(0.037)
(0.357)
No
Yes
No
Yes
No
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
Yes
13.18%
15.79%
15.39%
17.83%
1,350
1,214
1,350
1,214

This table shows the impact of team diversity on fund performance across fund locations using the Morningstar U.S.
domestic equity mutual fund sample from 1992 to 2010. It reports the estimates from panel regressions of fund
performance on three team diversity measures across funds located in financial centers and other places. The
dependent variable includes two performance measures, (4U) and (4C) which are the monthly risk-adjusted net
fund returns using unconditional and conditional versions of Carhart (1997) four-factor model, respectively.
Independent variables of interest are Tenure Diversity, measured by the coefficient of variation of all managers
tenure with the fund in a team; SAT Diversity, measured by the coefficient of variation of all managers SAT scores
within a team; and Manager Age (MAge) Diversity, measured by coefficient of variation of all fund managers age
(in years) within a team. Team Size equals the number of fund managers within a team in a given year. For teams
with four or more managers the Team Size equals four. Other independent variables are defined as in Table 4.
Financial center funds have their advisors located within 50 miles of Boston, Chicago, Los Angeles, New York,
Philadelphia, or San Francisco. All regression specifications include time and investment objective fixed effects and
the standard errors are clustered by fund. Each regression model also reports the p-values of coefficients, the number
of observations and the adjusted R2. ***, ** and * indicate significance at the 1%, 5%, and 10% levels, respectively.

114

Table 9
Effect of team management on risk-taking behavior

Teami,t
Fund Sizei,t-1
Fund Agei,t
Expensesi,t-1
Turnoveri,t-1
FCi,
SATi,t
Tenurei,t
MBAi,t
MAgei,t
Constant
Time & Obj.
FE
Cluster (Fund)
R2 (%)
Obs.

Total Risk
0.0797
(0.180)
0.0490***
(0.002)
-0.1058***
(0.002)
0.3180***
(0.000)
0.3300***
(0.000)
0.0013
(0.980)
-0.0159
(0.478)
0.0032
(0.608)
-0.1129
(0.140)
-0.1954
(0.175)
Yes

CAPM
Mrk1
IdoVol1
0.0102
0.0569
(0.385)
(0.137)
0.0144*** -0.0146
(0.000)
(0.201)
-0.0128* -0.0901***
(0.062)
(0.000)
0.0509*** 0.3614***
(0.000)
(0.000)
0.0806*** 0.2109***
(0.000)
(0.000)
0.0105
-0.0292
(0.338)
(0.422)
-0.0011 -0.0355**
(0.817)
(0.023)
-0.0014 0.0225***
(0.297)
(0.000)
-0.0194 -0.0977**
(0.187)
(0.046)
-0.0528*
-0.0724
(0.075)
(0.448)
Yes
Yes

Mrk4
0.0096
(0.216)
0.0087***
(0.000)
-0.0026
(0.580)
0.0042
(0.637)
0.0330***
(0.000)
0.0080
(0.267)
0.0018
(0.558)
-0.0027***
(0.003)
-0.0003
(0.973)
-0.0213
(0.276)
Yes

Unconditional Carhart Model

SMB
HML
MOM
IdVol4
0.0267*
0.0301**
-0.0030
-0.0061
(0.056)
(0.044)
(0.699)
(0.787)
-0.0037
-0.0064
0.0008 -0.0200***
(0.296)
(0.124)
(0.735)
(0.005)
-0.0252*** -0.0226*** 0.0103** -0.0428***
(0.001)
(0.007)
(0.027)
(0.001)
0.1106*** -0.0330*
-0.0010 0.2253***
(0.000)
(0.071)
(0.919)
(0.000)
0.0798*** -0.0888*** 0.0668*** 0.1001***
(0.000)
(0.000)
(0.000)
(0.000)
0.0059
-0.0066
0.0029
-0.0299
(0.666)
(0.662)
(0.707)
(0.163)
-0.0049
0.0066
-0.0049
-0.0146
(0.389)
(0.322)
(0.108)
(0.132)
0.0064*** 0.0039**
-0.0015 0.0144***
(0.000)
(0.022)
(0.109)
(0.000)
-0.0171
0.0110
0.0143 -0.0859***
(0.283)
(0.525)
(0.122)
(0.004)
-0.0680** 0.0705*
-0.0279
-0.0142
(0.044)
(0.065)
(0.159)
(0.801)
Yes
Yes
Yes
Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes
58.00
12,891

Yes
18.56
12,286

Yes
45.46
12,286

Yes
6.90
12,286

Yes
31.71
12,286

Yes
12.12
12,286

Yes
10.03
12,286

Yes
33.15
12,286

This table shows the effect of management structure on risk-taking behavior of mutual funds using the Morningstar
(MS) U.S. domestic equity mutual fund sample from 1992 to 2010. The table reports the estimates from panel
regressions of fund risk-taking on Team and other controls. The dependent variable includes different measures of
risks. Total Risk is defined as the standard deviation of monthly net fund returns over the past twelve months. Mrk1
is the market risk defined as the coefficient of the market portfolio based on the CAPM performance evaluation
model. IdVol1 is the standard deviation of the funds residual return from the CAPM model. Mrk4, SMB, HML, and
UMD are coefficients of market, size, book-to-market, and momentum portfolios based on the Carhart (1997) fourfactor performance evaluation model. IdVol4 is the standard deviation of the funds residual return from the Carhart
(1997) model. The independent variable of interest is Team, defined as a dummy variable which equals one if the
fund has two (or more) fund managers and zero if the fund has only one fund manager at the end of calendar year.
Other independent variables include various fund and manager characteristics as controls. Fund Size is the log of
total net assets under management of the fund. Fund Age is the log of the difference between the funds inception
year and the current year. Family Size is the log of total net asset under management of the funds family. Expenses
is the annual total expense ratio of the fund. Turnover is the minimum of aggregated sales or aggregated purchases
of securities of the year divided by the average 12-month total net assets of the fund. FC is the dummy variable
which equals one if the fund is in a financial center and zero otherwise. Financial center funds have headquarters
located within 50 miles of Boston, Chicago, Los Angeles, New York, Philadelphia, or San Francisco. Tenure is the
number of years the fund manager remains with the fund. SAT is the SAT score (divided by 100) of matriculates of
the fund managers undergraduate institution. MBA is defined as a dummy variable which equals one when a fund
manager (or at least one of the team members) has MBA degree and zero otherwise. MAge is the log of fund
managers age in current year. All regression specifications include time and investment objective fixed effects and
the standard errors are clustered by fund. Each regression model also reports the p-values of coefficients, the number
of observations and the adjusted R2. ***, ** and * indicate significance at the 1%, 5%, and 10% levels, respectively.
115

Table 10
Effect of team management on fund characteristics

Teami,t
Fund Sizei,t-1
Fund Agei,t
Family Sizei,t-1
Turnoveri,t-1
Volatilityi,t-1
Flowsi,t-1
FCi

Expenses
(1)
(2)
-0.0252** -0.0198
(0.043)
(0.273)
-0.0474*** -0.0527***
(0.000)
(0.000)
0.0064
-0.0117
(0.544)
(0.397)
-0.0245*** -0.0134***
(0.000)
(0.007)
0.0004*** 0.0003**
(0.000)
(0.013)
0.0244*** 0.0231***
(0.000)
(0.000)
-0.0049*** -0.0052***
(0.001)
(0.010)
0.0154
0.0060
(0.320)
(0.753)

Expensesi,t-1

Turnover
(3)
(4)
-0.0551** -0.1243***
(0.012)
(0.000)
-5.7641*** -5.0287***
(0.000)
(0.000)
-1.4391 1.7573
(0.350)
(0.310)
3.6593*** 1.7497**
(0.000)
(0.021)
6.3197*** 6.5111***
(0.000)
(0.000)
-0.0378 0.1958
(0.885)
(0.557)
12.2349*** 12.8597***
(0.000)
(0.000)
13.8426*** 10.5228***
(0.000)
(0.001)

Fund Size
(5)
(6)
0.0071
0.0216*
(0.410)
(0.081)
0.9300*** 0.9313***
(0.000)
(0.000)
-0.0341*** -0.0456***
(0.000)
(0.000)
0.0305*** 0.0294***
(0.000)
(0.000)
-0.0167** -0.0046
(0.012)
(0.572)
-0.0130*** -0.0156***
(0.000)
(0.000)
0.0367*** 0.0413***
(0.000)
(0.000)
-0.0118 -0.0047
(0.194)
(0.685)
-0.0543*** -0.0601***
(0.000)
(0.000)

(4U)i,t-1
Obj. Flowi,t-1
Mgr. controls
Constant
Time & Obj. FE
Cluster (Fund)
R2 (%)
Obs.

Yes
Yes
Yes
17.96
22,407

Yes
Yes
Yes
Yes
16.57
13,279

Yes
Yes
Yes
9.38
20,854

Yes
Yes
Yes
Yes
13.57
12,312

116

Yes
Yes
Yes
93.18
20,566

Yes
Yes
Yes
Yes
92.96
12,136

Flows
(7)
(8)
0.0449** 0.0757**
(0.043)
(0.020)
-0.2245*** -0.2210***
(0.000)
(0.000)
-0.0733*** -0.0993***
(0.000)
(0.000)
0.0922*** 0.0843***
(0.000)
(0.000)
-0.0139
0.0109
(0.417)
(0.656)
-0.0055
0.0007
(0.493)
(0.936)

-0.0142
(0.547)
-0.1940***
(0.000)
0.1982***
(0.000)
0.1732**
(0.024)
Yes
Yes
Yes
9.59
20,565

-0.0028
(0.923)
-0.1882***
(0.000)
0.2158***
(0.000)
0.1598
(0.118)
Yes
Yes
Yes
Yes
9.87
12,135

Table 10 (continued)
This table shows the effect of management structure on different fund characteristics of U.S. domestic equity mutual
funds from 1992 to 2010. The table reports panel regressions estimates of different fund characteristics on Team and
other controls. The dependent variable includes: Expenses, defined as the annual total expense ratio of the fund;
Turnover, defined as the minimum of aggregated sales or aggregated purchases of securities of the year divided by
the average 12-month total net assets of the fund; Fund Size, defined as the log of total net assets under management
of the fund; and Flows, defined as the net growth in total net assets under management of the fund over the past
year. The independent variable of interest is Team, defined as a dummy variable which equals one if the fund has
two (or more) fund managers and zero if the fund has only one fund manager at the end of calendar year. Other
independent variables include various fund and manager characteristics as controls. Fund Age is the log of the
difference between the funds inception year and the current year. (4U) is the monthly risk-adjusted net fund return
using Carhart (1997) four-factor model. Family Size is the log of total net asset under management of the funds
family. Volatility (%) is the standard deviation of monthly net fund returns over the past 12 months for the fund. FC
is the dummy variable which equals one if the fund is a financial center fund and zero otherwise. Financial center
funds have headquarters located within 50 miles of Boston, Chicago, Los Angeles, New York, Philadelphia, or San
Francisco. Tenure is the number of years the fund manager remains with the fund. SAT is the SAT score of
matriculates of the fund managers undergraduate institution. MBA is defined as a dummy variable which equals
one when a fund manager (or at least one of the team members) has MBA degree and zero otherwise. MAge is the
log of fund managers age in current year. All regression specifications include time and investment objective fixed
effects and the standard errors are clustered by fund. Each regression model also reports the p-values of coefficients,
the number of observations and the adjusted R2. ***, ** and * indicate significance at the 1%, 5%, and 10% levels,
respectively.

117

80

3000

70
2500
60

40

1500

30
1000
20
500
10

0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Single-managed funds

Team-managed funds

Total number of funds

Figure 1.
Evolution of mutual fund management structure from 1992 to 2010.
This figure shows the percentage of single-managed and team-managed funds along with the total number
of funds in our sample for 1992 to 2010. The left-hand side vertical axis represents the percentage of
single- and team-managed funds out of the total funds in our sample each year. The right-hand side vertical
axis represents the total of funds in our sample each year. The horizontal axis represents each year included
in our sample.

118

Number of Funds

Percent of Funds

2000
50

Chapter 4
Deception and Managerial Structure:
A Joint Study of Portfolio Pumping and
Window Dressing Practices

119

4.1

Introduction
In this article, we study whether organizational structure impacts the likelihood of

deception.36 In particular, we examine whether team-based organizations deter agents

from engaging in deceptive and unethical behavior. We achieve this goal by examining
the extent of portfolio pumping and window dressing the two fund practices that are
considered illegal or quasi-illegal among single-managed and team-managed funds in
the U.S. mutual fund industry (see Appendix for the U.S. Securities and Exchange
Commissions (SEC) litigation cases involving both these practices). Portfolio pumping
is a practice when fund managers artificially inflate their year-end (and often quarterend) performance by placing large orders on existing holdings (see Zweig, 1997; Carhart,
Kaniel, Musto, and Reed 2002; Bernhardt and Davies, 2005). Market regulators regard
this action as illegal. Another type of fund managers trading behavior that is largely
perceived as being dishonest, although without a formal status of illegal activity, is
window dressing. It is a practice when fund managers buy (sell) stocks that recently
performed well (bad) just before the funds holdings are made public to give the
impression that theyve been holding good stocks in their portfolios for a while (e.g., see
Lakonishok, Shleifer, Thaler, Vishny, 1991; Sias and Starks, 1997; He, Ng, and Wang,
2004; Ng and Wang, 2004; Meier and Schaumburg, 2006; Agarwal, Gay, and Ling,
2011).
The relation between organizational structure and agents incentives is well
known (see Arrow, 1974). The predisposition of team-based organizations to cheat may
be lower than that of individuals due to three main factors: social, economic, and
psychological.37 First, teams may increase the cost of cheating by greater social pressure
36

There are several types of deception (lies). We follow Gneezys (2005) classification and assume for the
purposes of our work that deception is an increase of the payoff to the liar and decrease of the payoff to the
liars counterpart.
37
We use words deception and cheating interchangeably. In economics literature, cheating is often
associated with the free-rider problem (shirking) rather than illegal behavior.
120

and peers monitoring (e.g., see Arnott and Stiglitz, 1991; Mas and Moretti, 2009).38
Teams may also reduce the benefits from cheating since they divide their total production
output among all members, thus transforming high-powered incentives into low-powered
ones and reducing each individual members monetary incentives to cheat (e.g., see Ma,
Moore, and Turnbull, 1988; Kandel and Lazear, 1992; Acemoglu, Kremer, and Mian,
2008). Finally, when working in teams, individuals may experience higher moral
pressures such as guilt aversion (see Charness and Dufwenberg, 2006). However, almost
all the aforementioned studies are theoretical, and few existing empirical results are
related only to free-riding. There is no any empirical evidence on the relation between
organizational structure and deception.
Our data comes from Morningstar Direct and covers actively managed U.S.
domestic equity mutual funds from January 2, 1992 to December 31, 2010. These funds
belong to one of the four investment objectives: aggressive growth, growth, growth &
income, and equity income. To properly disentangle any potential impact of managerial
structure on fund deception tactics, we account for several fund-specific variables, such
as investment objective, total assets under management, trading frequency, and
performance all of which may have incremental impact on the propensity to cheat.
Using standard methodologies in the literature, we test portfolio pumping on daily
returns and window dressing on quarterly returns to match the frequency in reporting of
fund portfolio holdings.
First, we examine the impact of managerial structure on portfolio pumping.
Consistent with prior findings, we find strong evidence of portfolio pumping over the
whole sample period. However, it is present more among single-managed than team-

38

In 2010, the SEC started a whistleblower program to encourage people to report fraud within their own
organization
by
providing
them
with
financial
incentives
and
protection
(see
http://www.sec.gov/whistleblower). This program makes fraud reporting easier, thus deterring illegal
trading activities.
121

managed funds, at both the year-end and quarter-ends. The average end-of-year
(beginning-of-year) daily excess returns among single-managed funds are different from
those of the rest of the year by 32bps (-26bps). The same returns for team-managed funds
differ from those of single-managed ones by -0.11bps and 0.04bps for the end-of-year
and beginning-of-year, respectively. These differences are highly statistically significant.
Moreover, we find that the evidence of portfolio pumping is decreasing with the number
of fund managers in a team. For example, two-manager funds show -8bps and 2bps
differences with single-managed funds for the end-of-year and beginning-of-year daily
returns, respectively, but these differences for funds with five or more managers are 16bps and 11bps, respectively. This constitutes 50% lower returns on the last day of the
year and 42% higher return in the first day of the year, respectively, among funds with
five or more managers as compared to single-managed funds. The decreasing relation
between the extent of portfolio pumping and team size holds across all fund investment
objectives, but it is more profound among aggressive growth and growth funds.
We analyze how team size affects portfolio pumping across different fund sizes.
We find evidence of portfolio pumping across all fund sizes, but its extent is again
smaller among team-managed funds in all instances, at both the year- as well as quarterends, with the exception of the year-end for the smallest quartile of funds. However, even
in this size quartile, funds experience much weaker pumping when managed by teams of
five or more managers. In a similar vein, portfolio pumping activity is present across all
turnover quartiles, but, as expected, it is stronger among high turnover funds. Importantly
though, even among funds with the lowest turnover, team-management consisting of five
or more people helps reduce this activity.
We also relate the extent of portfolio pumping across managerial structures for
funds with different prior performances. In contrast to previous studies (e.g., Carhart et
al., 2002), we find that portfolio pumping can be at least as profound among the worst
122

performing funds as among the best performers. Notably, we observe that the strongest
evidence of portfolio pumping occurs among the worst-performing single-managed
funds. It appears that managers of these funds have the highest incentives for making the
performance of their funds look better and very low pressures for not undertaking any
illegal trading activities.
Next, we examine window dressing. Overall, team-managed funds sell less
extreme losing stocks and buy less extreme winning stocks than their single-managed
counterparts. When looked at the quarterly trading activity, we find, consistent with prior
studies, that the evidence of window dressing, more specific trading activity at the yearend, is concentrated in sells of extreme losing stocks. Importantly, while single-managed
funds are involved in more selling of bad performing stocks in the fourth quarter of the
year compared to the previous three quarters, the trading activity of these types of stocks
among team-managed ones is similar throughout the year. Moreover, the difference in
selling intensity of the most underperforming stocks between team-managed and singlemanaged funds is decreasing (increasing in magnitude) in team size across all quarters. In
addition, we document an absence of window dressing practice among team-managed
funds across all four fund investment objectives. Yet, the selling intensity of the worst
performing stocks among single-managed funds is always higher in at the end-of-theyear.
Then, given the fact that some of the characteristics of team-managed funds may
again affect their ability to window dress, we analyze the impact of fund size, turnover,
and performance on the established negative relation between the propensity to window
dress and team size. We observe that the selling intensity of the worst performing
securities even among the largest single-managed funds is prone to window dressing.
The difference in their selling intensity of bad stocks is again economically and
statistically larger in the fourth quarter of the year as compared to the first three quarters.
123

The largest team-managed funds have similar selling intensity throughout the year.
Similarly, when we look at fund turnover quartiles, we continue observing the same
pattern with selling of the worst performance stocks: economically sizable window
dressing is observed among single-managed funds but not team-managed. Across fund
performance quartiles we find that the selling rate of poorly performing stocks in teammanaged funds is significantly lower in the fourth quarter compared to the first three
quarters of the year in the middle performance range. Yet, in the same performance
brackets, single-managed funds significantly increase their trading towards the end of
year.
Finally, we conduct our window dressing tests over the period of 1996-2000.
Greenwood and Nagel (2009) mention that window dressing is likely to be observed
more during the Dot-com bubble since many funds at that time would be interested in
reporting that they were holding high-performing telecom and internet stocks. Indeed,
our results show that the extent of window dressing is more prevalent in the late 1990s,
yet, again only among single-managed funds.
Thus, our study shows that team management significantly inhibits managers
drive to deceive.

In particular, deceptive tactics of investment managers such as

portfolio pumping and window dressing are largely the prerogatives of single-manager
funds. The three potential explanations for our results can be linked to peer monitoring,
monetary incentives, and psychological factors. Due to data limitations, we are unable to
differentiate across these explanations for more ethical behavior of team-managed funds.
Nonetheless, our findings provide a clear picture that, whatever the reason may be, teammanagement in the mutual fund industry is beneficial to both individual investors and the
public as a whole, at least, from to the perspective of reduction in illegal or quasi-illegal
activities.

124

The rest of the article is organized as follows. Section 2 provides motivation for
differences in incentives to deceive between individuals and teams. Section 3 examines
the extent of portfolio pumping among team-managed and single-managed funds.
Section 4 focuses on the relation between managerial structure and window dressing. The
descriptive statistics of data are present within each of these two sections. Section 5
concludes.

4.2

Motivation and Related Literature

It has been understood for a long time that groups behave differently from

individuals. Le Bon (1896) is the first to introduce the idea of a group mind,
differentiating it from a mind of a single individual. Since then, many studies in various
fields, including economics and finance, have attempted to compare group and individual
decision making in terms of performance and risk taking. The related literature is divided
into two camps. On the one side, many papers argue that decisions made within groups
are inferior to those made by individuals.39 This may result from extreme decisions by a
dominant team member or a reduction in critical thinking in each team member for the
sake of more conformity across the entire group. In economics, the negative effects of
groups are usually associated with cheating (free-riding) by some group members that
lead to the loss of productivity (e.g., see Holmstrom, 1982; Rasmusen, 1987; Nalbantian
and Schotter, 1997). Likewise, few finance studies find no benefits of teamwork in
enhancing the performance of professional money managers (e.g., Chen, Hong, Huang,
and Kubik, 2004; Massa, Reuter, and Zitzewitz, 2010).
On the other side, some theoretical and empirical evidence shows that teams
outperform individuals and do not take excessive risks. For example, Sah and Stiglitz
39

See, for example, Moscovici and Zavalloni (1969) and Janis (1982).
125

(1986, 1991) and Sharpe (1981) show that the opinion of a team is the average of
opinions of each team member, and, therefore, teams help diversifying individuals
opinions. Barry and Starks (1984) provide a theoretical setting suggesting that teams in
investment funds may reduce portfolio risk. However, there are very few empirical
studies that find evidence of increased performance in teams based on theories of opinion
and risk diversification in groups.40 Hamilton, Nickerson, and Owan (2003) find that
teams increase productivity, and that this increase is more apparent among earliest team
members. Patel and Sarkissian (2012) use equity mutual fund data and observe that teammanaged funds outperform single-managed ones without resorting to extra risk taking.41
An additional dimension where a team behavior may differ from that of an
individual is the likelihood of deceptive and illegal behavior. The probability of
involving in an illegal action depends on its costs and benefits. Becker (1968) argues that
criminals are rational agents: they weight the cost and benefit of a crime before actually
committing it. Different organizational structures imply different costs and benefits of
deceptive behavior. First, teams increase social pressures and provide an easy ground for
mutual supervision, thus reducing deception opportunities and increasing the cost of
deviating from the right behavior. Arnott and Stiglitz (1991) argue that peers
monitoring is important in labor markets because workers (e.g., portfolio managers) are
often in a better position to monitor their co-workers (e.g., co-portfolio managers) than
are employers (e.g., a fund company or investors). Mas and Moretti (2009) conclude that
workers in a team experience disutility if they are observed behaving selfishly by their
peers, irrespective whether their co-workers sanctions are formal or informal. Second,
teams provide a different compensation structure, thus reducing the benefits of cheating.
Ma et al. (1988) argue that the principal can overcome the problem of cheating by
40

The majority of existing studies in this area are experimental (e.g., see Bornstein and Yaniv, 1998; Bone
et al., 1999; Barber et al., 2003; Cooper and Kagel, 2004; and Blinder and Morgan, 2005; among others).
41
Other papers, such as Adams and Ferreira (2010) and Bar, Kempf, and Ruenzi (2011), find that teams
take less extreme decisions than individuals, but they provide no evidence of better performance in teams.
126

linking one agents contract to other agents output. Kandel and Lazear (1992) find that
peer pressure and monitoring are more effective when profits are shared in by all
members of the organization (e.g., partnership). Acemoglu et al. (2008), using a career
concerns model and some evidence from pension funds, show that when agents are
provided with high-powered incentives, which induce them to apply sufficient amount of
good efforts, these incentives may also encourage agents to use bad efforts to improve
their observed performance. Acemoglu et al. (2008) further argue that working in teams
may transform high-powered incentives of individual team members into low-powered
ones resulting in lesser frequency of bad behavior.42 Third, there are psychological
factors that explain why individuals may be less inclined to deceive when working in a
team. For instance, Charness and Dufwenberg (2006), using a model based on contract
theory, find that when agents exhibit guilt aversion then communication among them
may enhance their trustworthy behavior. Thus, teams are less likely to deceive than
individuals. Moreover, the positive effects of peers monitoring and social pressures, as
well as economic costs of deceptive behavior are likely to increase with team size.
Therefore, the larger is the team the less likely that its members will cheat.
Various experimental studies generally support a view that groups (not crowds)
behave smarter than individuals.43 Studies like Bornstein and Yaniv (1998), Cooper and
Kagel (2005), and Sutter (2009) argue that groups are more rational than individuals. In
particular, groups behave more strategically and learn more quickly to act strategically
than individuals. Charness et al. (2007) find that the more salient are the links among
group members, the more often group members select actions producing the largest
payments for both themselves and the rest of the group.

42

Jacob and Levitt (2003) show that high-powered incentives often lead to such distortions in behavior as
cheating.
43
Large groups with loosely defined ties may show off the negative characteristics of a crowd.
127

The next problem is to find a data source which would allow us to confidently
test whether there is a relation between organizational structure and deception. In this
respect, mutual funds provide one of the best datasets for analyzing the impact of group
decision making on the likelihood and extent of deceptive actions. There are several
reasons for that. First, at present, mutual funds provide one of the largest single sources
of occupational data. They represent the largest cross-sectional sample of firms within a
single industry and provide the longest time-series of data covering about two decades of
observations with sufficiently large details. Second, the proportion of team-managed and
single-managed funds is such that it allows one to make inferences about their relative
performance, risk-taking, and deception propensity while dealing with comparable
samples. Third, fund industry in general, and mutual funds in particular, have been
identified with certain types of practices that are perceived illegal or quasi-illegal on the
part of investors and government bodies. These are two trading actions: portfolio
pumping and window dressing.44 Portfolio pumping is a practice when fund managers
place large orders on existing holdings to artificially inflate their year-end and often
quarter-end performance. This is a very distractive practice for investors since after a
temporary gain in performance, stock prices usually fall back to previous levels once the
impact from the positive price pressure is over. Zweig (1997), Carhart et al. (2002), and
Bernhardt and Davies (2005) document that portfolio pumping is quite common across
various fund types. Market regulators regard this action as illegal and the SEC has
changed few portfolio managers with this behavior. (See the Appendix, sub-section A.1,
for some recent SEC cases related to portfolio pumping.)
44

Another type of investment activity that may have ill-motivated trades is risk-shifting (e.g., see Brown,
Harlow, and Starks, 1996; Chevalier and Ellison, 1997; Goetzmann, Ingersoll, Spiegel, and Welch, 2007;
Huang, Sialm, and Zhang, 2011). It is a practice of changing the funds risk exposure to maximize its
performance by the reporting date and to attract additional fund flows. However, this activity is not
regarded as unethical, since even good performing funds with skilled managers may resort to risk-shifting
for simply maximizing the returns on their investments. Also, to the best of our knowledge, there has not
been any official litigation case related to risk-shifting (unlike portfolio pumping and window dressing).
Therefore, we do not consider this trading tactic as universally unethical and do not examine it in our
study.
128

Another type of fund managers trading behavior that perceived as being

dishonest is window dressing. It is a practice when fund managers buy (sell) stocks that
recently performed well (bad) just before the funds holdings are made public giving the
impression that theyve been holding good stocks in their portfolios for a while.
Lakonishok et al. (1991) observed these trading patterns among pension funds. He et al.
(2004) as well as Ng and Wang (2004) document similar behavior across a variety of
financial institutions. Sias and Starks (1997) find the evidence of the turn-of-the-year
effects not only among institutional investors but also individuals. Yet, they attribute
their findings not so much to window dressing as to tax-loss-selling. It is indeed more
difficult to identify whether funds have been involved in window dressing activities than
whether they practice portfolio pumping. However, in spite of this difficulty, there are
cases when the SEC has explicitly cited window dressing tactics while charging portfolio
managers with illegal trading schemes. (See the Appendix, sub-section A.2, for the
SECs case related to window dressing.) Moreover, with recent increase in fund
performance reporting at the quarterly frequency, the incidences of window dressing are
likely to occur not only at the end of the year.

4.3

Portfolio Pumping and Managerial Structure

4.3.1

The Detail of Portfolio Pumping Phenomenon and its Estimation Methodology

It has been widely documented in both academic literature and professional

reports that returns of stocks and equity funds exhibit various seasonality effects. Of
particular interest was the observation of unusually large fund returns at the New Years
Eve. While some evidence of artificial stock price inflation by fund managers has been
making the headlines in popular press in the 1990s (see Zweig, 1997), Carhart et al.

129

(2002) offered the first comprehensive study on both yearly and quarterly fund
performance manipulation. This frequency of abnormal patterns in fund returns coincides
with the reporting frequencies among mutual funds.45 Ippolito (1992), Sirri and Tufano
(1998) and others observe that money flows into the best performing funds. Since it is in
fund managers compensation interests to have increasing inflows to their funds, they
have strong incentive to inflate their performance by the reporting dates. Expectedly,
Meier and Schaumburg (2006) and Agarwal et al. (2011) show that funds with poor
recent performance are more likely to engage in window dressing.
There also exist some theoretical studies that justify the existence of portfolio
pumping and/or provide some predictions on the extent of this phenomenon across funds.
Bhattacharyya and Nanda (2009) develop an equilibrium model where managers have
incentives to alter the closing prices of their security holdings. Bernhardt and Davies
(2009) show that portfolio pumping is persistent, that is, those mutual funds who are
involved in portfolio pumping in one quarter are likely to do it again in the following
quarter.
Since the results of Carhart et al. (2002) became public around the year 2000, the
SEC began scrutinizing suspicious fund trading activities and enforcing the existing
trading laws much better. As a result of these actions, in the June of 2001, SEC filed the
first fraud charges against a fund manager for market manipulation and portfolio
pumping. Duong and Meschke (2011) find a substantial decrease in portfolio pumping
activity afterwards. However, our focus is not so much on the changes in magnitude of
speculative price manipulation over time but on the cross-sectional differences in the
extent of portfolio pumping related trading between team-managed and single-managed
funds.
45

Reflecting the position that more transparency is better than less, in May 2004 the SEC increased the
required portfolio disclosure frequency from semi-annual to quarterly frequency. Prior to 2004 funds could
voluntarily report on a quarterly basis.
130

The primary source of mutual fund data is the Morningstar Direct database.46 Our
sample covers actively managed U.S. domestic open-end equity mutual funds from
January 2, 1992 to December 31, 2010. We focus on funds that belong to aggressive
growth (includes small company), growth, growth & income, and equity income
investment objectives. We exclude all sector, balanced, international, and index funds
from our analysis. The dataset includes daily fund returns (net of expenses), funds size,
measured by the total net assets (TNA) under management of the fund at the end of
calendar year, and fund turnover, computed as the minimum of aggregated sales or
purchases of securities in a year divided by the average 12-month TNAs of the fund. All
fund characteristics except fund returns are at individual fund level, so we aggregate
mutual fund share class level return observations to individual fund level using a unique
fund identifier in Morningstar Direct. To obtain fund returns in excess of a benchmark,
we subtract the daily fund returns from the returns of S&P 500 index. To minimize the
effect of outliers on our analysis, we winsorize daily excess fund returns at 1% and 99%
levels.
The Morningstar database also contains names of fund managers responsible for
day-to-day management of fund each year and the exact joining and leaving dates of fund
managers. We determine the managerial structure of funds based on the total number of
fund managers at the end of the calendar year. If a fund names only one fund manager at
the end of calendar year, we classify that fund as single-managed for that year. If a fund
names two or more fund managers, we classify that fund as team-managed. Further, we
divide team-managed funds into funds with two, three, four, and five (or move) distinct
fund managers at the end of calendar year, denoted 2FM, 3FM, 4FM, and 5+FM,
respectively. We remove all fund-years where fund manager names or tenure dates are
missing. Our final sample covers 3,252 unique funds with 7,053,857 daily observations.
46

Several recent studies show that Morningstar data on managerial structure is superior to that of CRSP
(see Massa et al., 2010; Patel and Sarkissian, 2012).
131

To estimate the managerial structure impact on portfolio pumping, we amend the

Carhart et al. (2002) methodology. Specifically, our regression model is:

ri ,t = b0 + b1YENDt Teami + b2YBEGt Teami + b3 QENDt Teami + b4 QBEGt Teami +

b5 MENDt Teami + b6 MBEGt Teami + b7 YENDt + b8YBEGt + b9 QENDt +
b10 QBEGt + b11 MENDt + b12 MBEGt + b13Teami + ei ,t ,
(1)
where ri,t is the fund i daily return (net of expenses) in excess of the daily S&P500 index
return. Independent variables include Teami, which is a dummy variable equals to one if
fund i has two (or more) fund managers and zero otherwise. YEND and YBEG are the last
and first trading day of year dummies, respectively. QEND is the last trading day of the
quarter, that is, March, June or September dummy; QBEG is the first trading day of the
quarter, that is, April, July or October dummy. MEND is the last trading day of February,
April, May, July, August, October or November dummy; and MBEG is the first trading
day of February, March, May, June, August, September, November or December
dummy. The coefficients of primary interest are those on the interaction terms of Team
and YEND, b1, YBEG, b2, QEND, b3, and QBEG, b4. They indicate how much fund
returns around the end of the year and end of quarters are different from average returns
during the rest of the year.
Table 1 shows the summary statistics of data that we use to measure the level of
portfolio pumping. It reports the mean and standard deviation of daily excess returns of
funds across various team sizes, as well as their respective number of observations
(divided by 1000). It also gives these return statistics across funds with different
investment objectives. The average returns of team-managed funds are higher than
single-managed ones, consistent with evidence in Patel and Sarkissian (2012). Across
investment objectives, the highest returns are observed, as expected, in the aggressive
growth category while the lowest in growth & income and equity income categories.
The average excess returns of team-managed funds are higher than single-managed ones
132

for all four fund investment objectives. The table also provides summary statistics on two
important fund characteristics that are known to be related to fund returns. These are
fund size, measured by the total net assets under management of the fund at the end of
calendar year. We can see that the average fund size is somewhat larger for teammanaged funds. However, the average fund size for funds managed by less than five
people is, in fact, smaller than that of single-managed fund. Only funds with five or more
managers have substantially larger total net assets than their single-manager counterparts.
The turnover of team-managed funds is lower than that of single-managed ones for any
team size.

4.3.2

Test Results
Table 2 shows the aggregate results on the portfolio pumping activity across

funds with different managerial structures. It reports the end-of-year and beginning-ofyear, end-of-quarter, and beginning-of-quarter coefficients and their corresponding pvalues (in parentheses) for single-managed funds, across all team-managed funds, and
separately for funds with various team sizes. The standard errors are clustered by fund.
Consistent with Carhart et al. (2002) and others, we find strong evidence of portfolio
pumping both around the year-end and quarter-ends. Importantly, the most profound
evidence of this seasonal trading activity is concentrated in single-managed funds. The
average daily excess returns of single-managed funds at the year-end and quarter-ends
differ from their returns during the rest of the year by 32bps and 20bps, respectively. The
same return differences among team-managed funds are lower by 11bps and 5bps. This
implies, that team-managed funds earn about 33% (25%) lower additional returns on the
last day of the year (quarter) compared to single-managed funds. Similar pattern is
detected for the beginning-of-year and beginning-of-quarter returns. These returns for
single-managed funds differ from those of the rest of the year by -26bps and -21bps,
133

respectively, but are less negative by about 4bps for team-managed funds. Furthermore,
we notice that the evidence of portfolio pumping is decreasing with the number of fund
managers in a team. For example, two-manager funds exhibit -8bps and 2bps differences
with single-managed funds for the end-of-year and beginning-of-year daily returns,
respectively. Yet, the same differences for funds with five managers are substantially
larger standing at -16bps and 11bps, respectively. This implies that funds with five or
more managers experience 50% lower returns on the last day of the year and 42% higher
returns in the first day of the year that funds with only one manager.
The next issue is to identify whether portfolio pumping activity patterns
documented in Table 3 are present across all fund investment categories, various fund
sizes and occur irrespective of average fund turnover. Table 3 presents results on
portfolio pumping evidence across four investment objectives and various fund manager
team sizes. We notice that the largest extent of pumping occurs, not surprisingly, among
aggressive growth funds, followed by growth funds. For example, the daily excess
returns at the year-end and year-beginning among single-managed aggressive growth
funds are 50bps and -49bps, respectively. The quarter-end and quarter-beginning results
are similar, standing at 40bps and -41bps. The magnitude of end-of-year (beginning-ofyear) returns among team-managed aggressive growth funds is less positive (negative)
than that of single-managed ones by 15bps (7bps). Similar to the overall picture in Table
2, we again observe that the dampening effect of team management on pumping activity
increases with team size. Among aggressive growth funds, the strength of portfolio
pumping for funds with five of more managers is lower by about 35% than that for
single-managed funds: the daily returns for funds with five and more managers around
December 31 January 1 are -22bps and 17bps (compare with 50bps and -49bps for
single-managed funds, respectively).

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Table 4 reports the estimation results of daily fund returns around the year- and
quarter-ends for four fund size quartiles. Quartile 1 includes the smallest 25% of all
funds, while Quartile 4 the largest 25%. The evidence of portfolio pumping is present
across all fund sizes, but, consistent with previous literature, the spread in the magnitudes
between positive returns in the last day of the year and negative returns in the first day of
the year are larger for the smallest size quartile. Yet, this pattern is observed only among
single-managed funds. Team-managed funds, even the smallest ones, exhibit much less
positive year-end returns and much less negative beginning-of-year ones. Similar
patterns are observed for returns around the quarter-ends. As before, the effect of teammanagement on the reduction of portfolio pumping is increasing with team size across all
fund size quartiles. The takeaway from this table is that not only the smallest but also the
largest funds are not immune from portfolio pumping, but that team management
alleviates this problem significantly, especially when teams are comprised of more than
three people.
Table 5 shows the estimation results of daily fund returns around the year- and
quarter-ends for four fund turnover quartiles. Quartile 1 includes funds with the lowest
25% turnover, while Quartile 4 funds with the highest 25% turnover. Again, not
unexpectedly, we find more evidence of portfolio pumping among funds with the highest
turnover rates based on returns around both year- and quarter-ends. That is, that are
accustomed to trade a lot, are also more prone to portfolio pumping activity. The table
shows that the management team impact on returns around the year-ends and quarterends are similar to all previous tables: portfolio pumping significantly decreases with
team size.
Thus, Tables 2-5 show that the propensity of funds managers to artificially alter
returns at the end of reporting periods, including the year-end is substantially reduced
when managers act within a team, especially teams of four, five or more managers.
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Importantly, this reduction is not a characteristic of any one fund investment objective,
size or turnover. What remains to be seen is how group decision making impacts the
extent of portfolio pumping across funds with various performance. We accomplish this
in Figures 1 and 2.47
Figure 1 shows fund returns around the year-end depending on fund performance
for all funds and separately for single-managed and team-managed funds. The upper part
of the plot shows daily excess fund returns on the last trading day of the year; the lower
part on the first trading day of the year. Fund performance is measured from the first
trading day of the year to the second-to-last day of the same year and is split into 20
performance bins by 5% each. Similar to Carhart et al. (2002), we find a U-shaped
pattern between the end-of-year returns and fund performance for the whole sample of
funds, as well as for the sub-samples of single- managed and team-managed funds. We
also observe an inverse U-shaped pattern between the beginning-of-year returns and fund
performance. What is different from Carhart et al. (2002) is that, unlike them, we find
that the evidence of portfolio pumping is more profound not among high-performing
funds, but those in the lowest yearly performance. For example, for the full sample of
funds, while excess positive returns at the year-end are about the same for funds with
both the worst and the best performance (around 33bps), the year-beginning returns are
markedly lower among the worst performing funds (close to an average of 30bps for the
bottom 15bps of performance) than their best performing counterparts (about -25bps).
Nevertheless, substantial year-end return manipulation evidence among high performing
funds indicates, as other studies also concluded, that funds that have very high likelihood
of being classified as top performers have sufficient incentives to increase that
possibility.
47

We also conduct cross-sectional tests similar to those in Carhart et al. (2002) to analyze whether the
relation between funds subsequent returns over any two trading days is more negative on the first day of
the year and quarter. Our results, consistent with the earlier evidence, show more reverse relation for these
days. They are available on request.
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More interesting for our analysis are the differences in portfolio pumping
between single-managed and team-managed funds. As we can see, for any fund
performance, the year-end returns are higher for single-managed funds than teammanaged ones. The same picture (with minus sign) holds almost throughout all
performance bins for the year-beginning returns: these returns are less negative for teammanaged funds than single-managed ones in all but the second-to-the-best performance
bin. In addition, unlike previous studies, using the fund performance dimension, we can
state that the largest extent of portfolio pumping occurs among the worst-performing
single-managed funds. One can easily explain this. Managers of single-managed funds
anticipating that their funds will fall in the lowest performance percentiles have, on the
one side, very high incentives to make their returns look better and, on the other,
relatively low pressures for not getting involved in any form of unethical or illegal
trading behavior. For these types of funds, the cost of cheating (probability of being
caught) versus the benefit from it (improved fund performance, increased inflows) is
much lower than among analogous team-managed funds. When single-managed funds
are successful in deceiving the public, they can enjoy all the benefits from their unethical
actions themselves, while the benefits of cheating in team-managed funds are shared by
all team members. In addition, while the chances of being caught with illegal trading
activity, ceteris paribus, must be equal across all funds, the cost of cheating in teammanaged funds may still be higher than in single-managed ones due, for instance, to
various psychological factors (see Charness and Dufwenberg, 2006).
Figure 2 provides more refined information on managerial structure relative to
Figure 1. It depicts fund returns around the year-end depending on fund performance
across manager teams of different sizes: single manager, two or three managers, and four,
five, or more managers. For the ease of clarity, the daily excess return data for funds with
two or three managers as well as four, five or more managers are averaged. The curve for
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single-managed funds is the same as in Figure 1 and is shown for convenience.

Consistent with all our previous tests, we see that the magnitude of portfolio pumping
again diminishes with team size. For instance, the scale of positive returns at the end-ofyear and the beginning-of-year among best performing funds with four, five and more
managers is the lowest among all manager team sizes and is not much different from
similar returns of funds with average performance. Thus, Figures 1 and 2 show that such
illegal trading as activity portfolio pumping is practiced primarily among single-managed
funds, especially those with the worst performance.

4.4

Window Dressing and Managerial Structure

4.4.1

The Details of Window Dressing Phenomenon and its Estimation Methodology

For a long time there is strong consensus among academics, financial industry,

and regulatory bodies that the disclosure of trading activity by professional money
managers is very useful, since, in this way, people are able to exercise more control over
those who handle their investments. As a result, fund managers are required to make their
holdings public on a regular basis. While the idea of providing more disclosure on
holdings to current and potential investors seems noble, it may lead to unintended
consequences on the part of fund managers such as short-term portfolio reshuffling with
the goal of better performing assets to be shown to the public. Although not without
some reservations, many academic studies demonstrate that excessive trading activity of
equity mutual funds around the reporting times such as the end of calendar year as well
as end of quarters can often be classified as window dressing (see Lakonishok et al.,
1991; He et al., 2004; Ng and Wang, 2004). Window dressing is primarily associated

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with funds selling their badly performed stocks and buying those with recent strong price
appreciation just before presenting their holdings to their clients and shareholders.
We analyze window dressing activity across funds with different managerial
structure using three databases: Morningstar Direct, Thomson-Reuters Mutual Fund
Holdings database and CRSP Stock Price database. The Morningstar Direct database
contains information related to managerial characteristics of mutual funds such as names
of fund managers, their joining and termination dates as well as other important fund
characteristics such as performance, assets under management and portfolio turnover
rate. We focus on U.S. domestic equity mutual funds that belong to aggressive growth,
growth, growth & income, and equity income investment objectives from 1992 to 2010.
We exclude all funds that belong to sector, balanced, international and index fund
categories from our analysis.
The Thomson-Reuters Mutual Fund Holdings database contains, for each fund,
complete stock holdings at the end of a given quarter. The dataset includes name of stock
holdings, number of shares held in the current portfolio for each stock holding and net
changes in shares held since previously reported portfolio. Following Lakonishok et al.
(1991), we focus our analysis on all common stocks traded on the NYSE, AMEX and
NASDAQ. Finally, we obtain stock prices, returns, and other stock related information
for all stocks in our analysis from CRSP.
We link the Morningstar mutual fund sample to the Thomson-Reuters holding
database using MFLINKS. To do this, we first match each fund in the Morningstar
sample to CRSP mutual fund database using individual fund tickers and date of
inception. In cases where the fund ticker information is missing, we use fund names
along with their date of inception for matching purposes. Then using each funds unique
identifier in CRSP (CRSP_FUNDNO), we obtain each funds unique portfolio identifier

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(FUNDNO) using MFLINKS file. This matching technique results in 2,238 funds
(almost a 70% match with the sample used in Section 3 on portfolio pumping) with a
total of 332,983 observations.
To determine whether managers engage in window dressing, we follow
Lakonishok et al. (1991). Each quarter we classify stocks held by mutual funds into
performance quintiles based on stock returns over the past year up to the end of that
quarter. The lowest (highest) quintile represents the stocks that have performed the worst
(best) over the past year. Then we estimate the total dollar value of holdings, purchases
and sales for each fund in each performance quintile by multiplying the number of shares
each fund holds, buys, and sells each quarter by the average of beginning and end-ofquarter stock prices.48 Formally, we define the selling intensity as

Selling Intensity =

(SELL(i, q, k ) HOLD(i, q 1, k ))
(iSELL(i, q, k ) iHOLD(i, q 1, k ))

(2)

where SELL(i,q,k) is the dollar value of sales by fund k in quarter q and performance
group i, and HOLD(i,q-1,k) is the dollar value of holdings at the end of the quarter q-1 of
the exact same stocks as those in performance group i in quarter q. SELL and HOLD are
defined using the average of beginning and end of quarter q prices. Similarly, the buying
intensity is defined as

Buying Intensity =

(BUY (i, q, k ) BUY (i, q, k ))

i

(UNIV .HOLD(i, q ) UNIV .HOLD(i, q ))

(3)

where BUY(i,q,k) is the dollar purchases by fund k in performance group i in quarter q

and UNIV.HOLD(i,q) is the value of CRSP universe holding in quarter q in performance

48

It is important to point that we only observe net changes in shares held by a fund over a given quarter
and not all trades that it makes during the same quarter.
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group i. Again, BUY and UNIV.HOLD are computed using the average of beginning and
end of quarter q prices.
Table 6 shows the summary statistics of trading intensity across mutual funds
with different managerial structures. It reports the mean and standard deviation of selling
and buying intensities of funds across various team sizes, as well as their respective
number of observations (divided by 1000). The table also provides summary statistics on
fund excess returns, size, and turnover three important fund characteristics that may
affect the extent of window dressing practice. Fund excess return is the quarterly excess
fund return (in percent) computed as the difference between the quarterly net fund return
and the quarterly S&P 500 index return. Fund size and turnover are defined as in Table 1
and show similar trends with manager team size as those in that table.
The selling and buying intensities are shown for fund portfolio holdings classified
as Extreme Losers and Extreme Winners. Extreme Losers is defined as the lowest stock
performance quintile each quarter, where stocks have the lowest returns over the past
year up to the end of that quarter. Extreme Winners is defined as the highest stock
performance quintile each quarter, where stocks have the highest returns over the past
year up to the end of that quarter. We can see that single-managed funds have higher
selling intensity for losing stocks, 1.30 versus 1.27. Moreover, the selling intensity of the
worst performing stocks decreases uniformly with team size. A funds with two managers
on average sells 29% more of extreme losers (relative to its holdings of those stocks)
than it sells of all stocks, while a fund with five of more managers sells only 21% more
of those stocks. This constitutes a 30% reduction in the selling intensity of the worst
performing stocks among funds with five or more managers relative to single-managed
funds.

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Note that the selling intensity of the best performing stocks is relatively stable
across all team sizes, and its magnitude is higher than that of the worst performing
stocks. This implies that funds in general, irrespective of their managerial structure, are
keener on getting rid of recent winning stocks than recent losers. Next, we look at the
buying intensity. Here, we can again observe that fund purchases of extremely bad
performing stocks are similar between single- and team-managed funds, are do not differ
much with team size. Finally, almost the same picture emerges for the practice of fund
buying of extreme losers. Yes, the only difference here is that funds with five or more
portfolio managers report much smaller intensity rate than not only single-managed
funds but also funds with fewer than five managers.

4.4.2

Test Results
Table 7 shows the effect of managerial structure on window dressing. It reports

the equal-weighted average selling and buying intensities of the worst performing and
best performing stocks over funds and years comparing across the first three quarters and
the last quarter of the year. The estimates are for the whole sample, as well as for singlemanaged and team-managed funds. The standard errors are shown below the mean
estimates. We also report two difference tests. Diff(Q4-13) is the difference between
quarter 4 and quarters 1-3 across selling and buying intensities, respectively. Diff(TeamSingle) is the difference of means between single and team-managed funds within
quarters 1-3 and quarter 4. The p-values for these tests are in parentheses.
The test results of particular interest are those corresponding to the selling
intensity of extreme losers followed by the buying intensity of extreme winners. We
observe that across all funds the average selling intensity of the worst performing stocks
is similar around the year: the difference between selling of these stocks in the fourth

142

quarter is economically and statistically indistinguishable from that in the first three
quarters of the year. More importantly, the same result holds for team-managed funds
they show even somewhat lower selling activity in bad stocks at the year-end. However,
single-managed funds behave differently. Their quarter 4 selling rate of the worst
performing securities is higher by 3.1% than that in the first three quarters. That is, in
quarter 4, a single-managed fund on average sells 3.1% more of its extremely bad
performing stocks than in quarters 1-3, relative to funds sells of all stocks. This
difference, Diff(Q4-13), is statistically significant almost at the 5% level, similar to
results in Lakonishok et al. (1991) for the overall sample of pension funds.49
It is important to recognize that, as a reflection of average turnover differences
(see Table 6), the overall selling activity of extreme losing stocks (and some buying
activity as well) may be naturally lower among team-managed funds than their singlemanaged counterparts. Yet, another notable result of Table 7 is that not only the
difference in selling intensity of the worst performers is significantly lower among teammanaged funds, but the difference in this rate between the two managerial structures is
larger in the fourth quarter of the year. Therefore, we believe these trading differences
across managerial structures are not driven by such considerations as tax-loss selling at
the end of the year: rather they indicate different propensities to window dress between
single-managed and team-managed funds. On the buying side, among the best
performing stocks, we observe that both single-managed and team-managed funds show
significantly less purchasing activity in the fourth quarter of the year as compared with
the first three quarters. Finally, with respect to the results in the top-right and bottom-left
quadrants of the table, we only note that they are not providing any information on the

49

It is important to note is that while calculating the difference between quarter 4 and quarters 1-3, we
correct for the repeated observations within the same fund-quarter-return quintile category. Without this
correction, our t-statistics become comparable to those in He et al. (2004).
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existence of window dressing in mutual funds. Besides, all the corresponding difference
tests are insignificant.
In Table 8, we compare the selling and buying intensities of the worst and best
performing stocks across funds with different team sizes. Similar to Table 7, Panel A,
reports the average trading intensities for the two stock performance groups across the
three quarters and the fourth quarter of the year. Panel B shows the difference in means
between funds with two, three, four, and five (or more) fund managers and singlemanager funds within quarters 1-3 and quarter 4. We find that not only team-managed
funds do not sell bad stocks more intensely at the year-end on average, but also that this
evidence is uniform across team-managed funds irrespective of the team size. Only funds
with four managers exhibit somewhat higher selling rate of bad performing stocks in the
fourth quarter compared to the first three ones, but this difference is insignificant and, in
addition, its magnitude is still lower than that of single-managed funds. On top of that
notice from Table 6 that the sub-sample of four-manager funds is the smallest in our
analysis. More interestingly, we observe from Panel B that team-managed funds of any
team size show substantially lower selling intensity than single-managed funds
throughout the year. Also, the reduction in selling rate vis--vis single-managed funds is
increasing in team size and is statistically significant among funds with five or more
managers. Finally, as in Table 7, on the buying side, we do not observe any evidence of
specific trading patterns across quarters of the year or the size of fund management.
As with portfolio pumping, the next issue is to see whether window dressing
patterns shown in Tables 6-7 are different across fund investment categories, sizes or
turnover. Table 9 repeats the estimation of selling (Panel A) and buying (Panel B)
intensities for the best and worst performing stocks across four investment objectives and
different managerial structure. Note that due to the sizable sample reduction in
comparison to the overall results in Table 6, we expect fewer occurrences of statistical
144

significance in difference tests even for the same level of coefficients. Across all
investment objectives in Panel A, we find a consistently positive difference in selling
intensity between the fourth quarter and the first three quarters of the year among singlemanaged funds. Moreover, while this difference is small among aggressive growth funds
(0.5%), it is larger than 3.5% across the other three fund investment objectives, and, for
growth funds, due to their larger sample size, is also marginally significant. Yet, the
same difference is consistently negative among team-managed funds. Another interesting
observation is that even though we already know that team-managed funds on average
trade less than single-managed ones, and that their selling intensity of bad performing
stocks is lower at the year-end than in the first three quarter-ends, this pattern persist
across all funds investment objectives. The buying intensity results for the best
performing stocks in Panel B again confirm, consistent with our earlier findings and
those of other studies, that there are no evidence of more trading activity of this type at
the end of the year.
Table 10 shows the average selling and buying intensities of single- and teammanaged funds across quarters 1-3 and quarter 4 controlling for fund size (Panel A) and
fund turnover (Panel B). At the end of each quarter, funds are sorted into size quartiles
based on the total net assets under their management. Also at the end of each quarter
funds are sorted into turnover quartiles based on their annual turnover rates. The top
(bottom) quartile is classified as large (small) funds, while the top (bottom) quartile is
classified as high (low) turnover funds. In this table, we report the results for only these
two quartiles of fund sizes and turnover rates. All other measures are defined similarly to
previous tables. In Panel A, we notice an increase in selling intensity of bad performing
stocks among single-managed funds but not team-managed ones at the year-end relative
to the first three quarters in the subsets of both large and small funds. Moreover, this
increase is statistically significant and larger in magnitude for the sub-sample of large
145

funds versus small ones (5% versus 3%). As before, there is no evidence of purchases of
winning stocks at the end of the year across all fund types. In Panel B we see that, on
average, selling intensity is higher among low turnover funds than high turnover ones.
This subset of funds also demonstrates increased selling rates in the fourth quarter of the
year. The difference in the selling intensity of extreme losers for single-managed funds in
the fourth quarter versus the first three quarters is around 3%, although it is insignificant
due to the approximately four-fold reduction in the sample size. Contrary to this
outcome, low turnover team-managed funds at the year-end demonstrate a decrease even
of higher magnitude in the selling intensity of badly performed holdings.
Finally, we want to understand the impact of managerial structure on window
dressing depending on fund performance. Clearly, if a fund shows good performance
prior to reporting dates, its managers do not need to prove to their clients that their
portfolio holdings included good stocks. Also, if fund returns are much below the
industrys median, then, most likely, investors will be very puzzled by seeing many hot
stocks in a funds portfolio given its underperformance. Thus, a priori, we expect to see
more window dressing evidence in the middle fund performance groups, where the
benefits of this trading activity are the greatest.
Table 11 shows the results of our tests. It again reports the average selling and
buying intensities of single- and team-managed funds across quarters 1-3 and quarter 4.
The Winner (Loser) funds are those within the top 25% (bottom 25%) of median
performance across all funds in a given year. Fund performance is based on the year to
date net excess fund returns up to and including the last day of the given quarter. That is,
fund performance in quarter 1 is measured based on the net excess fund returns from
January to March; quarter 2 from January to June; quarter 3 from January to
September; and quarter 4 for the full calendar year. The rest of the format of Table 11 is
similar to previous tables.
146

First, we find that the selling intensity of loser stocks is higher for singlemanaged funds than team-managed ones across all four quartiles of fund performance
and all quarters of the year except in quarter 4 for the best performing funds. Second, we
find significantly higher selling rate of loser stocks in quarter 4 relative to quarters 1-3
only among single-managed funds and only in the middle two quarters of fund
performance. These differences for quartiles 2 and 3 are 5.4% and 7.6%, respectively.
Importantly, for the same performance quartiles, team-managed funds decrease their
selling intensity in quarter 4, and this decrease is even statistically significant for quartile
2 (-4.7% drop with a p-value of 7.4%). Third, on the two extremes of fund performance,
we find no significant changes in the selling intensity of loser stocks at the year-end
relative to quarters 1-3, although the overall change is positive for Winner funds and
negative for Loser funds. These patterns are consistent with the notion that window
dressing is more likely to occur among those funds that can gain the most from this
action, but even in those instances, team-managed funds behave diametrically different
from their single-managed counterparts. As in previous tables, we observe no evidence of
window dressing on the purchasing side.
Overall, Tables 7-11 provide substantial support regarding the impact of
managerial structure on such misleading trading activity of professional money managers
as window dressing. There is one caveat though. Like other authors, we do not assume
that any increase in fund trading activities at the quarter- or year-end is necessarily a
manifestation of window dressing. For example, in Table 11, we observe that winner
funds, both single- and especially team-managed, increase their selling rate of loser
stocks in quarter 4 relative to quarters 1-3. Some of this activity may also be related to
momentum trading or other legitimate strategies. However, cross-sectional differences in
trading activity between single- and team-managed funds that we observe under various
scenarios are likely to reveal the fundamental link between managerial structure and
147

trading practice. This relation is further reinforced by the consistency of our window
dressing results with the earlier ones on portfolio pumping.

4.4.3

The Dot-com Bubble: A Special Case of Window Dressing

Greenwood and Nagel (2009) mention that the window dressing practice is more

likely to occur at the times when there are more pressures on portfolio managers to report
that their holdings include highly publicized stocks or group of stocks. For example,
during the Dot-com bubble at the end of 1990s many funds would be interested in
reporting that they were holding high-performing telecom and internet stocks. We test
this in Table 12, which repeats our estimations from Tables 7 and 8 on the impact of
various managerial structures on window dressing but only over the years of 1996-2000.
Panel A depicts the results across all funds, as well as single-managed and team-managed
funds, while Panel B shows the difference tests between funds with different team sizes
and those with single manager. We observe that the evidence of window dressing is
indeed stronger in the late 1990s, but, importantly, again only among single-managed
funds. First, the selling intensity of extreme losers in the fourth quarter of the year for
single-managed funds is by 6.2% higher than that in the first three quarter of the year.
Note that in spite of the decrease in the sample size, the increase in selling of the worst
performing stocks at the year-end is again statistically significant almost at the 5% level.
As before, the difference in quarterly selling intensity between team-managed and singlemanaged funds increases both economically and statistically with team size, especially in
the fourth quarter, reaching the rate of 23% for the difference between funds with five or
more managers and their single-managed counterparts.
Table 12 also shows some evidence of window dressing on the purchasing side,
but again only among single-managed funds: their intensity of buying the best

148

performing stocks at the year-end in comparison to previous quarter trading rate is higher
by almost 3% (see Panel A), which is comparable in magnitude to the selling rate of
worst performers among single-managed funds across the full sample period in Table 7.
The difference tests in Panel B indicate that, similar to selling intensity differences, the
difference in buying intensity between team-managed and single-managed funds also
increases substantially with team size, reached for funds with five managers statistically
significant levels even in this reduced sample.

4.5

Conclusions
In this paper, we use U.S. domestic equity mutual fund and examine the extent of

two trading practices, portfolio pumping and window dressing across funds with
different managerial structure. These two practices, which are generally viewed as
unethical at best and even illegal, create an ideal ground for analyzing the potential
relation between the likelihood to deceive and organizational structure. Our results show
that team-managed funds are less likely to involve in these dishonest fund performance
enhancing activities. Moreover, in some instances, such as window dressing, based on
selling poorly-performed stocks at the end of quarters and the year, we are unable to fund
any significant evidence of such behavior among team-managed funds. Across all our
tests, we document a negative relation between the extent of the evidence of the two
trading tactics and team size. These cross-managerial structure results hold irrespective
of additional controls related to such fund characteristics as fund returns, size, and
turnover that could also affect the actual propensity of fund manager to deceive. We also
show that portfolio pumping activity, which is again greatly reduced among teammanaged funds, including the best performers, is present most profoundly among single-

149

managed funds showing the worst prior performance. Thus, our findings provide novel
empirical support for the benefits of team-management in the fund industry.

150

Appendix
A.1: SEC cases related to portfolio pumping
Case 1: Excerpted from Litigation Release No. 20046 / March 16, 200750
SEC v. Burton G. Friedlander et al., Civil Action No. 01 Civ. 4683 (KMW) (S.D.N.Y.)
On February 21, 2007, United States District Judge Kimba Wood entered final judgments by
consent against Burton Friedlander and four entities he formerly controlled. These final judgments
conclude the U.S. Securities and Exchange Commission's action, except for a final distribution by the
court-appointed receiver.
The Commission filed its original complaint in May 2001, alleging fraud in connection with
Friedlanders management of the assets of Friedlander International Limited, an overseas hedge fund. The
Commission alleged that Friedlander inflated the hedge funds net asset value by improperly and arbitrarily
valuing certain unlisted securities of a company in which Friedlander and entities he controlled had heavily
invested. The Commissions complaint also alleged that Friedlander engaged in portfolio pumping by
purchasing a thinly-traded common stock as part of a manipulative scheme to inflate the value of that stock
and to inflate the hedge fund's net asset value

Case 2: Excerpted from Litigation Release No. 21865 / February 25, 201151
SEC v. Todd M. Ficeto, Florian Homm, Colin Heatherington, Hunter World Markets, Inc., and Hunter
Advisors, LLC et al., Case No. CV-11-1637 GHK (RZx) (C.D. Cal. February 24, 2011)
The Securities and Exchange Commission charged two securities professionals, a hedge fund
trader, and two firms involved in a scheme that manipulated several U.S. microcap stocks and generated
more than $63 million in illicit proceeds through stock sales, commissions and sales credits.
According to the SECs complaint filed in the U.S. District Court for the Central District of
California, Homm along with Ficeto and Heatherington conducted the scheme from September 2005 to

50
51

See details at http://sec.gov/litigation/litreleases/2007/lr20046.htm.

See details at http://sec.gov/litigation/litreleases/2011/lr21865.htm.
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September 2007 The SEC alleges that Florian Homm of Spain and Todd M. Ficeto of Malibu, Calif.,
conducted the scheme through their Beverly Hills, Calif.-based broker-dealer Hunter World Markets Inc.
(HWM) with the assistance of Homms close associate Colin Heatherington, a trader who lives in Canada.
They brought microcap companies public through reverse mergers and manipulated upwards the stock
prices of these thinly-traded stocks before selling their shares at inflated prices to eight offshore hedge
funds controlled by Homm. Their manipulation of the stock prices allowed Homm to materially overstate
by at least $440 million the hedge funds performance and net asset values (NAVs) in a fraudulent practice
known as portfolio pumping

A.2: SEC cases related to window dressing

Case 1: Excerpted from Litigation Release No. 19170 / April 6, 200552
SEC v. Jeff Thomas Allen et al., Civil Action No. 05-453 (W.D. Pa.)
The Securities and Exchange Commission (Commission) announced that on April 6, 2005, it
filed a civil action in the United States District Court for the Western District of Pennsylvania against Jeff
Thomas Allen, of Pittsburgh, Pennsylvania, and James Barlow Smith, of Saxonburg, Pennsylvania. Allen
was the President, CEO, Chief Investment Officer and majority shareholder of Advanced Investment
Management, Inc. (AIM), a now-defunct investment adviser previously registered with the Commission.
Smith was AIMs Vice President of Equity Trading...
The Commissions Complaint alleges that AIMs investment strategy involved matching or
exceeding the performance of the S&P 500 Index through the use of derivatives rather than direct
investment in the equities that comprised the Index The Complaint further alleges that, from at least
January 2002 through July 2002, Allen and Smith conducted unauthorized trading in numerous client
accounts, and in violation of advisory agreements. In particular, from April through July 2002, during a
time when the S&P 500 Index dropped almost 29 percent, the defendants improperly increased market
exposure in an effort to recover from past losses. This trading caused market exposure in some accounts to

52

See details at http://sec.gov/litigation/litreleases/lr19170.htm.

152

reach levels as high as 500 percent, which, in turn, caused more than $415 million in client losses. In order
to conceal the effect of their trading, which otherwise would have been disclosed in monthly account
statements, Allen and Smith sold the unauthorized positions before month-end, and repurchased them
shortly thereafter. This strategy of window dressing prevented clients from discovering the scheme

153

Table 1
Summary Statistics of Daily Fund Returns and Fund Characteristics

Daily Excess Return

Mean
SD

Investment Objectives:
Aggressive Growth Mean
SD
Growth Mean
SD
Growth & Income Mean
SD
Equity Income Mean
SD
Obs.
Fund Size
Mean
SD
Fund Turnover
Mean
SD

Overall
0.010
0.567

Single
0.009
0.585

Team
0.011
0.553

2FM
0.011
0.561

Team Size
3FM
4FM
0.012
0.011
0.574
0.532

5+FM
0.011
0.511

0.017
0.721
0.010
0.547
0.005
0.419
0.005
0.473
7,053
1,080
4,600
0.900
1.076

0.016
0.741
0.009
0.569
0.003
0.422
0.004
0.483
3,013
1,040
4,070
0.961
1.383

0.018
0.706
0.010
0.531
0.007
0.417
0.006
0.462
4,040
1,110
4,960
0.856
0.774

0.018
0.720
0.010
0.537
0.006
0.417
0.004
0.484
1,988
745
2,090
0.859
0.767

0.018
0.729
0.011
0.551
0.007
0.424
0.010
0.451
939
931
2,590
0.903
0.915

0.017
0.636
0.011
0.502
0.007
0.389
0.008
0.438
652
2,620
11,100
0.796
0.632

0.020
0.681
0.008
0.504
0.012
0.444
0.007
0.404
459
917
2,350
0.830
0.660

This table reports the mean and standard deviation (SD) of daily returns of domestic equity mutual funds in
the U.S. across various managerial structures and investment objectives from January 2, 1992 to December
31, 2010. Based on the number of fund managers listed in Morningstar Direct database, funds are
categorized into two broad managerial structures: Single and Team. Funds with only one fund manager are
classified as Single whereas funds with more than one manager are classified as Team. Team Size
represents funds with two, three, four and five (or more) fund managers. Daily Excess Return is the daily
excess fund return (%) computed as the difference between the daily net fund return and the daily S&P 500
index return. Fund Size (millions, $) is the total net assets under the management of the fund at the end of
the year. Fund Turnover is the minimum of aggregated sales or aggregated purchases of securities in a year
divided by the average 12-month total net assets of the fund. The four fund investment objectives are
Aggressive Growth, Growth, Growth & Income, and Equity Income. The number of observations is
reported in 1000s.

154

Table 2
Effect of Managerial Structure on Portfolio Pumping Activity
Team Size
YEND
YBEG
QEND
QBEG

Single
0.323
(0.000)
-0.259
(0.000)
0.202
(0.000)
-0.213
(0.000)

Team
-0.106
(0.000)
0.043
(0.000)
-0.054
(0.000)
0.036
(0.000)

2FM
-0.081
(0.000)
0.021
(0.077)
-0.037
(0.000)
0.022
(0.007)

3FM
-0.107
(0.000)
0.025
(0.094)
-0.047
(0.000)
0.021
(0.067)

4FM
-0.139
(0.000)
0.073
(0.000)
-0.082
(0.000)
0.052
(0.000)

5+FM
-0.162
(0.000)
0.114
(0.000)
-0.098
(0.000)
0.087
(0.000)

This table reports panel regression coefficients of daily excess fund returns on managerial structure using
U.S. domestic equity mutual fund data from January 2, 1992 to December 31, 2010. The regression model
is:

ri ,t = b0 + b1YENDt Teami + b2 YBEGt Teami + b3 QENDt Teami + b4 QBEGt Teami +

+ b5 MENDt Teami + b6 MBEGt Teami +
+ b7 YENDt + b8 YBEGt + b9 QENDt + b10 QBEGt + b11 MENDt + b12 MBEGt + b13Teami + e i , t .
The dependent variable is the daily fund return (net of expenses) in excess of daily S&P500 index return.
Independent variables include Team, defined as a dummy variable which equals one if the fund has two (or
more) fund managers and zero otherwise; YEND the last trading day of year dummy; YBEG the first
trading day of the year dummy; QEND the last trading day of the quarter, that is, March, June or
September dummy; QBEG the first trading day of the quarter, that is, April, July or October dummy;
MEND the last trading day of February, April, May, July, August, October or November dummy; and
MBEG the first trading day of February, March, May, June, August, September, November or December
dummy. The coefficients reported in the table are: the interaction terms of Team and YEND, b1, YBEG, b2,
QEND, b3, and QBEG, b4. The standard errors are clustered by fund. The p-values for the test if the
estimates are different from zero are in parentheses.

155

Table 3
Effect of Managerial Structure on Portfolio Pumping across Investment Objectives
Team Size
Aggressive Growth
YEND
YBEG
QEND
QBEG
Growth
YEND
YBEG
QEND
QBEG
Growth & Income
YEND
YBEG
QEND
QBEG
Equity Income
YEND
YBEG
QEND
QBEG

Single

Team

2FM

3FM

4FM

5+FM

0.496
(0.000)
-0.489
(0.000)
0.400
(0.000)
-0.413
(0.000)

-0.155
(0.000)
0.068
(0.004)
-0.130
(0.000)
0.092
(0.000)

-0.117
(0.002)
0.035
(0.223)
-0.078
(0.002)
0.068
(0.001)

-0.171
(0.000)
0.048
(0.167)
-0.127
(0.000)
0.062
(0.039)

-0.212
(0.000)
0.131
(0.002)
-0.231
(0.000)
0.126
(0.000)

-0.223
(0.000)
0.169
(0.000)
-0.234
(0.000)
0.198
(0.000)

0.289
(0.000)
-0.231
(0.000)
0.168
(0.000)
-0.206
(0.000)

-0.113
(0.000)
0.044
(0.001)
-0.045
(0.000)
0.031
(0.000)

-0.088
(0.000)
0.020
(0.191)
-0.032
(0.001)
0.017
(0.069)

-0.115
(0.000)
0.042
(0.028)
-0.042
(0.000)
0.025
(0.058)

-0.144
(0.000)
0.069
(0.001)
-0.062
(0.000)
0.051
(0.002)

-0.162
(0.000)
0.104
(0.000)
-0.079
(0.000)
0.069
(0.000)

0.235
(0.000)
-0.116
(0.000)
0.095
(0.000)
-0.043
(0.000)

-0.022
(0.260)
0.030
(0.053)
0.005
(0.603)
0.003
(0.744)

-0.012
(0.569)
0.041
(0.031)
-0.005
(0.676)
0.003
(0.784)

-0.003
(0.909)
-0.028
(0.237)
0.025
(0.105)
-0.015
(0.317)

-0.015
(0.727)
0.033
(0.342)
0.023
(0.338)
-0.009
(0.774)

-0.074
(0.024)
0.067
(0.021)
-0.001
(0.943)
0.031
(0.061)

0.292
(0.000)
-0.100
(0.000)
0.145
(0.000)
-0.006
(0.698)

-0.082
(0.005)
-0.042
(0.147)
-0.038
(0.019)
-0.014
(0.510)

-0.060
(0.084)
-0.070
(0.058)
-0.031
(0.094)
-0.023
(0.366)

-0.087
(0.031)
-0.037
(0.420)
-0.038
(0.099)
0.000
(0.993)

-0.132
(0.012)
-0.019
(0.737)
-0.057
(0.100)
-0.021
(0.552)

-0.130
(0.027)
0.083
(0.190)
-0.052
(0.136)
0.015
(0.749)

This table reports panel regression coefficients of daily excess fund returns on managerial structure across
different investment objectives using the US domestic equity mutual fund data from January 2, 1992 to
December 31, 2010. The regression specification is as in Table 2, but it is rerun separately for each of the
four investment objectives: Aggressive Growth, Growth, Growth & Income, and Equity Income. All
variables are defined and reported as in Table 2. The p-values for the test if the estimates are different from
zero are in parentheses.

156

Table 4
Effect of Fund Size on Portfolio Pumping and Managerial Structure Relation
Team Size
Quartile 1 (Smallest)
YEND
YBEG
QEND
QBEG
Quartile 2
YEND
YBEG
QEND
QBEG
Quartile 3
YEND
YBEG
QEND
QBEG
Quartile 4 (Largest)
YEND
YBEG
QEND
QBEG

Single

Team

2FM

3FM

4FM

5+FM

0.369
(0.000)
-0.218
(0.000)
0.195
(0.000)
-0.216
(0.000)

-0.160
(0.000)
0.004
(0.866)
-0.063
(0.000)
0.030
(0.021)

-0.145
(0.000)
0.007
(0.782)
-0.052
(0.001)
0.025
(0.108)

-0.105
(0.003)
-0.037
(0.263)
-0.040
(0.050)
-0.006
(0.767)

-0.233
(0.000)
-0.023
(0.530)
-0.111
(0.000)
0.063
(0.015)

-0.255
(0.000)
0.081
(0.016)
-0.104
(0.000)
0.084
(0.000)

0.332
(0.000)
-0.280
(0.000)
0.221
(0.000)
-0.206
(0.000)

-0.098
(0.000)
0.055
(0.003)
-0.080
(0.000)
0.032
(0.015)

-0.053
(0.038)
0.022
(0.297)
-0.052
(0.001)
0.015
(0.351)

-0.136
(0.000)
0.056
(0.037)
-0.062
(0.001)
0.024
(0.235)

-0.140
(0.000)
0.124
(0.000)
-0.149
(0.000)
0.041
(0.103)

-0.168
(0.000)
0.114
(0.000)
-0.154
(0.000)
0.104
(0.000)

0.325
(0.000)
-0.316
(0.000)
0.226
(0.000)
-0.234
(0.000)

-0.108
(0.000)
0.090
(0.000)
-0.065
(0.000)
0.051
(0.000)

-0.095
(0.000)
0.071
(0.002)
-0.043
(0.007)
0.032
(0.047)

-0.124
(0.000)
0.066
(0.018)
-0.073
(0.000)
0.043
(0.050)

-0.102
(0.006)
0.136
(0.000)
-0.076
(0.003)
0.057
(0.024)

-0.131
(0.000)
0.154
(0.000)
-0.115
(0.000)
0.120
(0.000)

0.267
(0.000)
-0.221
(0.000)
0.167
(0.000)
-0.197
(0.000)

-0.060
(0.002)
0.018
(0.327)
-0.012
(0.295)
0.028
(0.035)

-0.032
(0.145)
-0.015
(0.498)
-0.003
(0.828)
0.019
(0.231)

-0.064
(0.021)
0.006
(0.828)
-0.014
(0.441)
0.020
(0.341)

-0.087
(0.015)
0.040
(0.199)
-0.002
(0.930)
0.048
(0.062)

-0.103
(0.002)
0.096
(0.002)
-0.037
(0.037)
0.049
(0.025)

This table reports panel regression coefficients of daily excess fund returns on managerial structure across
different fund size quartiles using U.S. domestic equity mutual fund data from January 2, 1992 to
December 31, 2010. The regression specification is as in Table 2, but it is rerun separately for each fund
size quartile. All variables are defined and reported as in Table 2. The p-values for the test if the estimates
are different from zero are in parentheses.

157

Table 5
Effect of Fund Turnover on Portfolio Pumping and Managerial Structure Relation
Team Size
Quartile 1 (Lowest)
YEND
YBEG
QEND
QBEG
Quartile 2
YEND
YBEG
QEND
QBEG
Quartile 3
YEND
YBEG
QEND
QBEG
Quartile 4 (Highest)
YEND
YBEG
QEND
QBEG

Single

Team

2FM

3FM

4FM

5+FM

0.270
(0.000)
-0.181
(0.000)
0.149
(0.000)
-0.145
(0.000)

-0.070
(0.000)
0.018
(0.291)
-0.038
(0.001)
0.016
(0.176)

-0.064
(0.005)
-0.016
(0.444)
-0.019
(0.158)
0.009
(0.507)

-0.058
(0.041)
-0.006
(0.815)
-0.032
(0.076)
0.021
(0.316)

-0.128
(0.000)
0.046
(0.139)
-0.074
(0.002)
0.005
(0.842)

-0.063
(0.097)
0.138
(0.000)
-0.076
(0.000)
0.039
(0.037)

0.298
(0.000)
-0.220
(0.000)
0.182
(0.000)
-0.189
(0.000)

-0.076
(0.000)
0.027
(0.137)
-0.047
(0.000)
0.046
(0.000)

-0.058
(0.010)
0.016
(0.481)
-0.033
(0.019)
0.033
(0.020)

-0.065
(0.010)
0.007
(0.784)
-0.046
(0.007)
0.026
(0.120)

-0.123
(0.000)
0.066
(0.032)
-0.067
(0.002)
0.072
(0.001)

-0.116
(0.000)
0.067
(0.029)
-0.075
(0.000)
0.094
(0.000)

0.327
(0.000)
-0.283
(0.000)
0.209
(0.000)
-0.224
(0.000)

-0.132
(0.000)
0.042
(0.026)
-0.051
(0.000)
0.037
(0.005)

-0.092
(0.000)
0.025
(0.270)
-0.039
(0.007)
0.019
(0.214)

-0.154
(0.000)
0.014
(0.642)
-0.054
(0.004)
0.022
(0.268)

-0.149
(0.000)
0.048
(0.181)
-0.039
(0.140)
0.079
(0.004)

-0.206
(0.000)
0.119
(0.000)
-0.085
(0.000)
0.079
(0.000)

0.328
(0.000)
-0.338
(0.000)
0.244
(0.000)
-0.281
(0.000)

-0.131
(0.000)
0.077
(0.000)
-0.079
(0.000)
0.046
(0.002)

-0.103
(0.000)
0.046
(0.061)
-0.054
(0.001)
0.039
(0.023)

-0.152
(0.000)
0.088
(0.009)
-0.053
(0.010)
0.000
(0.990)

-0.139
(0.002)
0.134
(0.001)
-0.160
(0.000)
0.060
(0.023)

-0.184
(0.000)
0.132
(0.001)
-0.148
(0.000)
0.137
(0.000)

This table reports panel regression coefficients of daily excess fund returns on managerial structure across
different fund turnover quartiles using U.S. domestic equity mutual fund data from January 2, 1992 to
December 31, 2010. The regression specification is as in Table 2, but it is rerun separately for each fund
turnover quartile. All variables are defined and reported as in Table 2. The p-values for the test if the
estimates are different from zero are in parentheses.

158

Table 6
Summary Statistics of Trading Intensity across Funds with Different Managerial Structures

Selling Intensity:
Extreme Losers Mean
SD
Extreme Winners Mean
SD
Obs.
Buying Intensity:
Extreme Losers Mean
SD
Extreme Winners Mean
SD
Obs.
Fund Excess Return
Mean
SD
Fund Size
Mean
SD
Fund Turnover
Mean
SD

Overall

Single

Team

2FM

Team Size
3FM
4FM

5+FM

1.286
0.939
1.449
0.889
240

1.304
0.953
1.440
0.892
97

1.273
0.928
1.455
0.887
142

1.288
0.943
1.466
0.886
69

1.289
0.939
1.451
0.899
31

1.280
0.934
1.455
0.902
16

1.207
0.867
1.429
0.862
25

1.423
1.161
1.420
1.077
293
0.744
5.193
702
2,747
0.884
1.077

1.428
1.168
1.437
1.107
121
0.694
5.417
737
2,615
0.948
1.398

1.419
1.156
1.408
1.056
171
0.779
5.030
677
2,836
0.836
0.751

1.453
1.187
1.427
1.086
84
0.798
5.122
468
1,413
0.836
0.732

1.386
1.122
1.419
1.056
38
0.780
5.448
642
1,781
0.894
0.911

1.373
1.142
1.420
1.032
19
0.726
4.692
528
1,376
0.812
0.630

1.399
1.117
1.325
0.973
28
0.760
4.338
1469
6,080
0.773
0.619

This table reports the mean and standard deviation (SD) of trading intensity among U.S. domestic equity
mutual funds across various managerial structures from January 1992 to December 2010. Based on the
number of fund managers listed in Morningstar Direct database, funds are categorized into two broad
managerial structures: Single and Team. Funds with only one fund manager are classified as Single
whereas funds with more than one manager are classified as Team. Team Size represents funds with two,
three, four and five (or more) fund managers. Selling Intensity is defined as

(SELL(i, q, k ) HOLD(i, q 1, k )) ( SELL(i, q, k ) HOLD(i, q 1, k )),

i

where SELL(i,q,k) is the dollar value of sales by fund k in quarter q and performance group i, and HOLD
(i,q-1,k) is the dollar value of holdings at the end of the quarter q-1 of the exact same stocks as those in
performance group i in quarter q. Buying Intensity is defined as

(BUY (i, q, k ) BUY (i, q, k )) (UNIV .HOLD(i, q ) UNIV .HOLD(i, q )),

i

where BUY(i,q,k) is the dollar purchases by fund k in performance group i in quarter q and UNIV.HOLD
(i,q) is the value of CRSP universe holding in quarter q in performance group i. Extreme Losers is defined
as the lowest stock performance quintile each quarter, where stocks have the lowest returns over the past
year up to the end of that quarter. Extreme Winners is defined as the highest performance quintile each
quarter, where stocks have the highest stock returns over the past year up to the end of that quarter. These
definitions follow Lakonishok et al. (1991). Fund Excess Return is the quarterly excess fund return (%)
computed as the difference between the quarterly net fund return and the daily S&P 500 index return. Fund
Size (millions, $) is the total net assets under the management of the fund at the end of the year. Fund
Turnover is the minimum of aggregated sales or aggregated purchases of securities of the year divided by
the average 12-month total net assets of the fund. The number of observations is reported in 1000s.

159

Table 7
Effect of Managerial Structure on Window Dressing Activity
Q1-Q3

Selling Intensity
Q4
Diff(Q4-13)

Q1-Q3

Buying Intensity
Q4
Diff(Q4-13)

Extreme Losers:
Overall
Single
Team
Diff(Team-Single)

1.282
0.005
1.296
0.008
1.276
0.007
-0.019
(0.075)

1.290
0.009
1.327
0.014
1.263
0.011
-0.064
(0.001)

0.007
(0.465)
0.031
(0.059)
-0.013
(0.324)

1.417
0.005
1.426
0.009
1.418
0.007
-0.008
(0.483)

1.422
0.009
1.434
0.015
1.424
0.013
-0.010
(0.596)

0.005
(0.625)
0.008
(0.646)
0.006
(0.693)

1.450
0.004
1.445
0.007
1.456
0.006
0.011
(0.254)

1.440
0.007
1.427
0.012
1.452
0.010
0.025
(0.103)

-0.009
(0.276)
-0.018
(0.193)
-0.004
(0.735)

1.437
0.005
1.451
0.009
1.416
0.007
-0.034
(0.002)

1.398
0.009
1.399
0.014
1.383
0.011
-0.016
(0.378)

-0.039
(0.001)
-0.052
(0.002)
-0.034
(0.012)

Extreme Winners:
Overall
Single
Team
Diff(Team-Single)

This table shows the effect of managerial structure on window dressing of U.S. domestic equity mutual
funds from January 1992 to December 2010. It reports the average selling and buying intensity of stocks
over funds and year comparing across the first three quarters and the last quarter of the year. Funds are
categorized into two broad managerial structures: Single, which are funds with only one fund manager and
Team, which are funds with two or more managers. Selling Intensity is defined as the ratio of stocks sold
in a performance group by a fund to holdings of the same stocks at the end of the previous quarter divided
by the ratio of total stocks sold in this quarter to holdings at the end of the previous quarter. Buying
Intensity is defined as the fraction of stock purchases in a performance group by a fund relative to the
fraction of the universe holdings in that performance group. Extreme Winners and Extreme Losers are
defined as in Table 6. The standard errors are shown below the mean estimates. Diff(Q4-13) is the
difference between quarter 4 and quarters 1-3 across selling and buying intensities, respectively.
Diff(Team-Single) is the difference of means between single and team-managed funds within quarters 1-3
and quarter 4. The standard errors are below intensity estimates. The p-values for the difference tests are in
parentheses.

160

Table 8
Window Dressing across Teams of Different Sizes
Panel A: Window dressing across team sizes
Selling Intensity (Extreme Losers)
Q1-Q3
Q4
Diff(Q4-13)
1.296
1.327
0.031
Single
0.008
0.014
(0.059)
1.295
1.269
-0.026
2FM
0.010
0.017
(0.178)
1.289
1.290
0.001
3FM
0.015
0.025
(0.982)
1.274
1.298
0.024
4FM
0.020
0.034
(0.547)
1.212
1.193
-0.019
5+FM
0.015
0.025
(0.522)

Buying Intensity (Extreme Winners)

Q1-Q3
Q4
Diff(Q4-13)
1.426
1.434
0.008
0.009
0.015
(0.646)
1.446
1.469
0.023
0.011
0.019
(0.277)
1.392
1.371
-0.021
0.015
0.025
(0.477)
1.375
1.366
-0.010
0.021
0.037
(0.815)
1.399
1.399
0.001
0.017
0.029
(0.987)

Panel B: Difference in selling and buying intensities across management structures

Selling Intensity (Extreme Losers)
Buying Intensity (Extreme Winners)
Difference
Q1-Q3
Q4
Q1-Q3
Q4
-0.001
-0.058
0.020
0.036
2FM - Single
(0.966)
(0.009)
(0.142)
(0.131)
-0.007
-0.037
-0.034
-0.063
3FM - Single
(0.696)
(0.205)
(0.055)
(0.034)
-0.021
-0.028
-0.051
-0.068
4FM - Single
(0.334)
(0.461)
(0.033)
(0.090)
-0.084
-0.134
-0.027
-0.035
5+FM - Single
(0.000)
(0.000)
(0.172)
(0.304)
This table shows window dressing activity of mutual funds managed by a single manager as well as by
teams of two, three, four, and five (or more) managers using U.S. domestic equity mutual funds from
January 1992 to December 2010. Panel A reports equal-weighted average selling and buying intensity of
extreme winner stocks and extreme loser stocks across the first three quarters and the fourth quarter of the
year. The standard errors are shown below the mean estimates. Panel B reports the difference in means
between funds with two, three, four, and five (or more) fund managers and single-manager funds within
quarters 1-3 and quarter 4. Single is defined as funds with only one fund manager; 2FM, 3FM, 4FM and
5+FM are funds with two, three, four, and five (or more) fund managers. Other measures are defined as in
Tables 6 and 7. Diff(Q4-13) is the difference between quarter 4 and quarters 1-3 across selling and buying
intensities, respectively. The standard errors are below intensity estimates. The p-values for the difference
tests are in parentheses.

161

Table 9
Managerial Structure and Window Dressing across Investment Objectives
Panel A: Selling intensity in extreme loser stocks
Aggressive Growth
Q1-Q3
Q4
Diff(Q4-13)
1.176
1.168
-0.009
Overall
0.010
0.017
(0.658)
1.195
1.200
0.005
Single
0.017
0.029
(0.880)
1.155
1.138
-0.022
Team
0.013
0.022
(0.507)
-0.062
Diff(Team-Single) -0.040
(0.063) (0.082)

Q1-Q3
1.314
0.007
1.306
0.011
1.315
0.009
0.008
(0.552)

Growth
Q4
Diff(Q4-13)
1.328
0.014
0.012
(0.287)
1.343
0.037
0.018
(0.082)
1.309
-0.005
0.015
(0.772)
-0.034
(0.159)

Growth & Income

Q1-Q3
Q4
Diff(Q4-13)
1.299
1.310
0.011
0.014
0.023
(0.675)
1.339
1.379
0.040
0.024
0.041
(0.388)
1.295
1.274
-0.021
0.019
0.030
(0.547)
-0.044
-0.105
(0.144) (0.035)

Q1-Q3
1.443
0.031
1.528
0.047
1.384
0.043
-0.144
(0.025)

Equity Income
Q4
Diff(Q4-13)
1.438
-0.005
0.051
(0.933)
1.583
0.055
0.075
(0.536)
1.262
-0.122
0.071
(0.151)
-0.321
(0.002)

Panel B: Buying intensity in extreme winner stocks

Aggressive Growth
Q1-Q3
Q4
Diff(Q4-13)
1.811
1.762
-0.049
Overall
0.012
0.020
(0.042)
1.855
1.809
-0.045
Single
0.021
0.034
(0.263)
1.766
1.698
-0.068
Team
0.016
0.026
(0.029)
-0.111
Diff(Team-Single) -0.089
(0.001) (0.008)

Q1-Q3
1.431
0.006
1.437
0.011
1.421
0.009
-0.017
(0.221)

Growth
Q4
Diff(Q4-13)
1.402
-0.030
0.011
(0.018)
1.371
-0.066
0.017
(0.001)
1.402
-0.018
0.014
(0.274)
0.031
(0.156)

Growth & Income

Q1-Q3
Q4
Diff(Q4-13)
0.964
0.941
-0.023
0.010
0.017
(0.240)
0.963
0.944
-0.020
0.017
0.029
(0.555)
0.928
0.901
-0.028
0.013
0.021
(0.275)
-0.035
-0.043
(0.100) (0.216)

Q1-Q3
0.879
0.021
0.874
0.029
0.833
0.029
-0.040
(0.322)

Equity Income
Q4
Diff(Q4-13)
0.847
-0.032
0.033
(0.422)
0.860
-0.014
0.050
(0.804)
0.772
-0.062
0.042
(0.263)
-0.088
(0.181)

This table reports the average selling and buying intensities of funds within different investment objectives comparing across quarters 1-3 and quarter 4. The
sample includes U.S. domestic equity mutual funds from January 1992 to December 2010. Investment objectives are: Aggressive Growth, Growth, Growth &
Income, and Equity Income. Panel A reports the average selling intensity within extreme loser stocks across quarters 1-3 and quarter 4. Panel B reports the
average buying intensity within extreme winner stocks across quarters 1-3 and quarter 4. Other measures are defined as in Tables 6 and 7. The standard errors are
shown below the mean estimates. Diff(Q4-13) is the difference between quarter 4 and quarters 1-3 across selling and buying intensities, respectively. Diff(TeamSingle) is the difference of means between single and team-managed funds within quarters 1-3 and quarter 4. The standard errors are below intensity estimates.
The p-values for the difference tests are in parentheses.

162

Table 10
Effect of Fund Size and Turnover on Window Dressing and Managerial Structure Relation
Panel A: Results by fund size
Selling Intensity (Extreme Losers)
Q1-Q3
Q4
Diff(Q4-13)
Large Funds:
1.227
1.277
0.051
Single
0.014
0.025
(0.072)
1.235
1.262
0.027
Team
0.013
0.022
(0.274)
0.008
-0.016
Diff(Team-Single)
(0.678)
(0.638)
Small Funds:
1.353
1.384
0.031
Single
0.020
0.034
(0.432)
1.342
1.287
-0.055
Team
0.016
0.026
(0.077)
0.011
0.097
Diff(Team-Single)
(0.663)
(0.020)
Panel B: Results by fund turnover
Selling Intensity (Extreme Losers)
Q1-Q3
Q4
Diff(Q4-13)
High Turnover Funds:
1.187
1.203
0.016
Single
0.014
0.024
(0.545)
1.223
1.232
0.009
Team
0.013
0.022
(0.709)
0.037
0.030
Diff(Team-Single)
(0.051)
(0.361)
Low Turnover Funds:
1.430
1.463
0.032
Single
0.022
0.036
(0.445)
1.413
1.376
-0.037
Team
0.019
0.031
(0.312)
-0.017
-0.086
Diff(Team-Single)
(0.547)
(0.066)

Buying Intensity (Extreme Winners)

Q1-Q3
Q4
Diff(Q4-13)
1.315
0.015
1.254
0.012
-0.060
(0.002)

1.311
0.025
1.226
0.020
-0.084
(0.007)

-0.004
(0.884)
-0.028
(0.235)

1.515
0.019
1.445
0.014
-0.071
(0.003)

1.482
0.031
1.427
0.025
-0.055
(0.163)

-0.033
(0.366)
-0.018
(0.535)

Buying Intensity (Extreme Winners)

Q1-Q3
Q4
Diff(Q4-13)
1.795
0.017
1.799
0.014
0.004
(0.854)

1.732
0.028
1.762
0.024
0.030
(0.415)

-0.063
(0.056)
-0.037
(0.172)

1.190
0.018
1.079
0.015
-0.111
(0.001)

1.129
0.029
1.043
0.023
-0.087
(0.018)

-0.061
(0.082)
-0.037
(0.195)

This table compares average selling and buying intensities of single- and team-managed funds across
quarters 1-3 and quarter 4 controlling for fund size (Panel A) and fund turnover (Panel B). The sample
includes U.S. domestic equity mutual funds from January 1992 to December 2010. At the end of each
quarter, funds are sorted into size quartiles based on the total net assets under their management. The top
(bottom) quartiles are classified as Large (Small) Funds. Also, at the end of each quarter, funds are sorted
into turnover quartiles based on the annual fund turnover. The top (bottom) quartiles are classified as High
(Low) Turnover Funds. Other measures are defined as in Tables 6 and 7. The standard errors are shown
below the mean estimates. Diff(Q4-13) is the difference between quarter 4 and quarters 1-3 across selling
and buying intensities, respectively. Diff(Team-Single) is the difference of means between single and
team-managed funds within quarters 1-3 and quarter 4. The standard errors are below intensity estimates.
The p-values for the difference tests are in parentheses.

163

Table 11
Effect of Fund Performance on Window Dressing and Managerial Structure Relation
Selling Intensity (Extreme Losers)
Q1-Q3
Q4
Diff(Q4-13)

Buying Intensity (Extreme Winners)

Q1-Q3
Q4
Diff(Q4-13)

Winner Funds:
Single
Team
Diff(Team-Single)

1.302
0.019
1.298
0.015
-0.004
(0.880)

1.323
0.031)
1.342
0.028
0.019
(0.653)

0.021
(0.567)
0.043
(0.161)

1.677
0.018)
1.627
0.014)
-0.051
(0.026)

1.626
0.029
1.600
0.024
-0.026
(0.491)

-0.051
(0.134)
-0.026
(0.346)

1.285
0.018
1.273
0.014
-0.012
(0.589)

1.360
0.030
1.263
0.023
-0.098
(0.009)

0.076
(0.025)
-0.010
(0.711)

1.370
0.017
1.352
0.013
-0.018
(0.384)

1.309
0.027
1.311
0.021
0.002
(0.948)

-0.062
(0.052)
-0.041
(0.102)

1.324
0.017
1.292
0.014
-0.031
(0.144)

1.377
0.028
1.246
0.022
-0.132
(0.001)

0.054
(0.093)
-0.047
(0.074)

1.278
0.016
1.301
0.020
0.023
(0.25)

1.266
0.025
1.221
0.020
-0.045
(0.155)

-0.012
(0.694)
-0.080
(0.001)

1.264
0.015
1.245
0.013
-0.019
(0.337)

1.245
0.026
1.207
0.020
-0.038
(0.244)

-0.019
(0.529)
-0.037
(0.129)

1.428
0.018
1.361
0.014
-0.066
(0.004)

1.365
0.029
1.364
0.025
-0.002
(0.963)

-0.062
(0.080)
0.002
(0.932)

Quartile 3:
Single
Team
Diff(Team-Single)
Quartile 2:
Single
Team
Diff(Team-Single)
Loser Funds:
Single
Team
Diff(Team-Single)

This table compares average selling and buying intensities of single- and team-managed funds across
quarters 1-3 and quarter 4 controlling for different fund performance quartiles. The sample includes U.S.
domestic equity mutual funds from January 1992 to December 2010. The Winner (Loser) funds are those
within the top 25% (bottom 25%) of median performance across all funds in a given year. Fund
performance is based on the net excess fund returns. Other measures are defined as in Tables 6 and 7. The
standard errors are shown below the mean estimates. Diff(Q4-13) is the difference between quarter 4 and
quarters 1-3 across selling and buying intensities, respectively. Diff(Team-Single) is the difference of
means between single and team-managed funds within quarters 1-3 and quarter 4. The standard errors are
below intensity estimates. The p-values for the difference tests are in parentheses.

164

Table 12
The Dot-Com Bubble: A Special Case of Window Dressing and Managerial Structure
Panel A: Window dressing during the Dot-Com bubble
Selling Intensity (Extreme Losers)
Q1-Q3
Q4
Diff(Q4-13)
1.255
1.278
0.022
Overall
0.012
0.019
(0.310)
1.261
1.323
0.062
Single
0.017
0.028
(0.055)
1.259
1.227
-0.032
Team
0.017
0.027
(0.334)
-0.003
-0.096
Diff(Team-Single)
(0.917)
(0.013)

Buying Intensity (Extreme Winners)

Q1-Q3
Q4
Diff(Q4-13)
1.154
1.169
0.014
0.009
0.013
(0.38)
1.147
1.174
0.027
0.013
0.020
(0.255)
1.144
1.137
-0.007
0.013
0.020
(0.756)
0.004
-0.003
(0.883)
(0.182)

Panel B: Difference in selling and buying intensities across management structures during Dot-Com
bubble
Selling Intensity (Extreme Losers)
Buying Intensity (Extreme Winners)
Difference
Q1-Q3
Q4
Q1-Q3
Q4
0.021
-0.049
0.006
-0.025
2FM - Single
(0.479)
(0.298)
(0.777)
(0.442)
-0.013
-0.102
0.067
0.041
3FM - Single
(0.747)
(0.116)
(0.023)
(0.363)
0.024
-0.202
-0.049
-0.044
4FM - Single
(0.698)
(0.052)
(0.287)
(0.531)
-0.118
-0.231
-0.188
-0.290
5+FM - Single
(0.032)
(0.008)
(0.000)
(0.000)
This table shows the impact of managerial structure on window dressing activity of equity mutual funds
during the Dot-com bubble. The sample includes U.S. domestic equity mutual funds from January 1996 to
December 2000. Panel A reports equal-weighted average selling and buying intensities of single- and
team-managed funds across quarters 1-3 and quarter 4. Panel B reports the difference in means between
funds with two, three, four, and five (or more) fund managers and single-manager funds within quarters 13 and quarter 4. Other measures are defined as in Tables 6 and 7. Diff(Q4-13) is the difference between
quarter 4 and quarters 1-3 across selling and buying intensities, respectively. Diff(Team-Single) is the
difference of means between single and team-managed funds within quarters 1-3 and quarter 4. The
standard errors are below intensity estimates. The p-values for the difference tests are in parentheses.

165

End of year

0.5

0.4

0.3

Fund daily excess return (%)

0.2

0.1

<< Worst

0
5

Fund performance percentile

Best >>

10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

-0.1

Beginning of year

-0.2

-0.3

-0.4

All funds

Single-managed

Team-managed

-0.5

Figure 1. Fund Returns around the Year-end for Different Managerial Structures and Performance.
The figure shows the relation between daily excess fund returns (in percent) on the last trading day of the
year (upper half of the plot) as well as the first trading day of the year (lower half of the plot) and fund
performance across all funds (dashed curve), single-managed funds (thick curve), and team-managed funds
(thin curve). Fund performance is measures from the first trading day of the year to the second-to-last day
of the same year and is split into 20 performance bins by 5% each. The sample covers the period between
January 1, 1992 and December 31, 2010.

166

End of year

0.5

0.4

0.3

Fund daily excess return (%)

0.2

0.1

<< Worst

0
5

Fund performance percentile

Best >>

10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

-0.1

Beginning of year

-0.2

-0.3

-0.4

Single-managed

2-3 managers

4-5 managers

-0.5

Figure 2. Fund Returns around the Year-end for Different Manager Team Sizes and Performance.
The figure shows the relation between daily excess fund returns (in percent) on the last trading day of the
year (upper half of the plot) as well as the first trading day of the year (lower half of the plot) and fund
performance across single-managed funds (thick curve), funds with two or three managers (dashed curve),
and funds with four, five and more managers (thin curve). The daily excess return data for funds with two
or three managers as well as four, five or more managers are averaged. Fund performance is measures from
the first trading day of the year to the second-to-last day of the same year and is split into 20 performance
bins by 5% each. The sample covers the period between January 1, 1992 and December 31, 2010.

167

Chapter 5
Conclusions

168

This thesis comprises of three essays that use the U.S. equity mutual fund
industry to test three important economic questions. In doing so, this thesis makes four
key contributions to the literature. First, we shed new light on the importance of
investors' economic expectations in investment decisions and provide a plausible
explanation to how investor expectations enter investors' investment decisions. We show
that economic expectations positively influence investors' investment decisions and
investors' put more weight on their expectations particularly when fund-specific
information is noisy and less reliable. Second, we document a large discrepancy in
managerial structure reporting in CRSP database. We find that CRSP database
inaccurately reports the number of portfolio managers responsible for day to day
activities of a fund. The discrepancy affects, on average, one-fifth of the sample per year.
Once we correct this discrepancy, we resolve the conflicting evidence in the existing
literature on the benefits of team compared to single managers. Third, we provide new
empirical evidence on benefits of teamwork conditional of team size, diversity and
geographical location. Our results not only show that team-managed funds outperform
single-managed funds but also find that the outperformance is the highest among threemember teams, teams with homogeneous members and teams located in financial
centers. Lastly, we are the first to empirically show that team-based managerial structure
can significantly reduce incentives of portfolio manager to cheat or engage in deceptive
behavior. Our results strongly suggest that team-managed funds are less likely to involve
in two deceptive trading practices, namely, portfolio pumping and window dressing. We
also document that exists a negative relation between team size and likelihood of
deception/cheating.
We now elaborate of the findings of each of the three essays in detail. In the first
essay, we explore the importance of investors' expectations about future economic
growth in their investment decisions. We also provide a plausible explanation to how
169

investor expectations might enter their investment decisions. We start by constructing a

new measure of investors' economic expectations (INVEXP) that captures what investors
think will happen to the overall economy in a year. INVEXP offers three distinct
advantages over existing proxies. First, it is a direct and cleaner measure because it uses
survey data from individual households and concentrates only on questions related to
investors' expectation about economy. Second, it is highly correlated with known state
variables which predict future economic growth. And third, it has desirable statistical
properties such as relative stability, stationarity and lines up very well with the known
historical periods of optimism and pessimism. Then, we investigate whether INVEXP
affects mutual fund flows. We find that INVEXP positively relates to mutual fund flows.
This result suggests that investors increase their allocation to riskier equity fund when
they are optimistic about the future. This effect is robust to inclusion of various fund
characteristics, such as performance and fees, which are known in the literature to affect
mutual fund flows as well as various macroeconomic variables, such as stock market
returns and interest rates. Then, we investigate the mechanism through which
expectations enter investors' investment decision-making process. Financial theory
argues that investors trade-off different pieces of information based on the quality of
information while making investment decisions. Consistent with financial theory, we
find that investors put more weight on their expectations in making investment decisions
particular for those funds which have noisy and poor quality of fund-specific
information. Overall, our main conclusion is that economic expectations positively
influences investors' investment decisions and becomes particularly important to
investors whenever the fund-specific information is noisy and less informative.
The second essay examines whether teams are better than single managers at
managing mutual fund portfolios. In addressing this question, we first highlight a large
discrepancy in reported managerial structure between CRSP and MorningStar. We find
170

that CRSP database inaccurately reports the number of portfolio managers responsible
for day to day activities of a fund. This discrepancy ranges between as low as 10 percent
to as high as 26 percent of entire sample per year. Once we correct this discrepancy, we
find a positive (and statistically significant) relation between teams and fund
performance, unlike a negative relation documented by previous literature using CRSP
data. In the second part of this essay, we focus on conditional effects of teamwork based
on team size, location and team diversity. First, we examine the relation between team
size and fund performance. We observe a non-linear relation between team size and fund
performance. In particular, we find that three-member teams tend to generate highest
fund performance relative to single-manager funds. This result shows that not all teams
are equal and that the benefit of teamwork depends on the number of team members.
Second, we investigate whether location of a fund affects the team-fund performance
relation. We show that funds gain from team management only when they are located in
financial centers. We find no difference in teams performance relative to single
managers in non financial centers. This result confirms the intuition that teams gain
advantage over single managers because of their ability to access and collect a large
amount of private information abundant in financial centers. Then, we examine whether
diversity among team members affects fund performance. We show that funds with
more homogeneous team members in terms of age and educational background
outperform those with more heterogeneous managers. Further, we also analyze the effect
of teams on other fund characteristics such as fund flows, fees, size and turnover. We
find that funds managed by teams of portfolio managers receive significantly higher
flows relative to funds managed by single managers, ceteris paribus. This result suggests
that investors at large tend to prefer and trust teams relative to single managers. Overall,
our results strongly indicate that team-based managerial structure is beneficial, but its
magnitude of its benefits depends on team size, diversity and geographical location.

171

Finally, the third essay investigates whether team-based managerial structure reduces
likelihood of deception or cheating. We find that teams involve in significantly less
cheating than individual fund managers. In particular, we show that team-managed funds
involve significantly less in portfolio pumping, an illegal trading activity, and do not
involve at all in window dressing, a quasi-illegal and dishonest trading activity. Further,
we also document a negative relation between the extent of these two illegal and quasiillegal activities and team size. These results are robust to various fund characteristics
that are known to correlate with teams and team size such as fund size, fund portfolio
turnover and fund return. There can be several mechanisms at play behind this
phenomenon. But in our opinion, there are three mechanisms that seem most important.
First, teams increase cost of cheating by peer monitoring. Peer monitoring by other team
members increases the likelihood of getting caught which in turn reduce the likelihood of
cheating. Second, teams reduce benefits accruing from cheating to individuals since the
output of their joint production is divided among other non-cheating members. So the
entire cost of cheating is borne by an individual while the benefit of cheating is shared
among all team members. And third, individuals working within a team may experience
higher moral pressures such as guilt aversion. This might deter individuals within a team
to work against the interests of the team as a whole. Unfortunately, due to data
limitations, we are unable to differentiate across these mechanisms. Overall, our results
strongly suggest that team-based managerial structure can effectively reduce the
prevalence of illegal or quasi-illegal activities within an organization.

172

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