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NEWS RELEASE: Is there an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets?

FOR IMMEDIATE RELEASE

New study:  Is there an Incentive for Active Retail Mutual Funds to Closet Index in Down Markets?

Researchers at Pace University and Touro College find incentive for active managers to closet index in down markets as investors do not reward outperformance with higher flows

New York, NY – July 25, 2013 — The relationship between fund performance and subsequent net fund flows is significantly different in up markets years as compared to down market years, according to a new study by researchers at Pace University and Touro College.

Professors Aron Gottesman and Matthew Morey of Pace University and Menahem Rosenberg of Touro College examined the relationship between annual fund performance and subsequent annual fund flows in both up and down markets. Specifically, the researchers find that fund performance does not drive subsequent flows nearly as much in down markets as it does in up markets.

“Indeed, in up markets, we find a strong positive relationship between fund performance and subsequent flows,” the researchers write. “Conversely, in down years, the amount of outperformance or underperformance does not significantly influence the next year’s fund flows. Hence, based on these results, there is an incentive for active managers to closet index in down markets as investors do not reward outperformance with higher flows.”

The researchers used a data set comprised of 15 years of open, retail, actively managed, no-load mutual funds over the period 1997-2011. They used retail funds because they capture individual investors who have been shown to be more subject to behavioral biases and because they pay the highest cost for closet indexing. Furthermore, they measured fund performance using a method that individual investors seem to respond to most, i.e., fund annual total returns relative to the Standard and Poor’s 500 index.

For a copy of the research paper, email wcaldwell@pace.edu.

BACKGROUND: Gottesman and Morey of Pace University’s Lubin School of Business are co-authors of previous studies including “Morningstar Mutual Fund Ratings Redux” (2006), “Manager Education and Mutual Fund Performance” (2006), “Predicting Emerging Market Mutual Fund Performance” (2007), “Does Better Corporate Governance Result in Higher Market Valuations in Emerging Markets?” (2009), “CEO Educational Background and Firm Financial Performance” (2010), and “Mutual Fund Corporate Culture and Performance” (2012). Their work has been cited by Financial Times, Forbes, New York Times, and Wall Street Journal.

About Pace University

Since 1906, Pace University has educated thinking professionals by providing high quality education for the professions on a firm base of liberal learning amid the advantages of the New York metropolitan area.  A private university, Pace has campuses in Lower Manhattan and Westchester County, NY, enrolling nearly 13,000 students in bachelor’s, master’s, and doctoral programs in its Lubin School of Business, Dyson College of Arts and Sciences, College of Health Professions, School of Education, School of Law, and Seidenberg School of Computer Science and Information Systems.

Media contact:  Bill Caldwell, Pace, 212-346-1597, wcaldwell@pace.edu

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