NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Mutual Fund Flows and Performance in Rational Markets

Jonathan B. Berk, Richard C. Green

NBER Working Paper No. 9275
Issued in October 2002
NBER Program(s):   AP

We develop a simple rational model of active portfolio management that provides a natural benchmark against which to evaluate observed relationship between returns and fund flows. We show that many effects widely regarded as anomalous are consistent with this simple explanation. In the model, investments with active managers do not outperform passive benchmarks because of the competitive market for capital provision, combined with decreasing returns to scale in active portfolio management. Consequently, past performance cannot be used to predict future returns, or to infer the average skill level of active managers. The lack of persistence in active manager returns does not imply that differential ability across managers is nonexistent or unrewarded, that gathering information about performance is socially wasteful, or that chasing performance is pointless. A strong relationship between past performance and the ow of funds exists in our model, indeed this is the market mechanism that ensures that no predictability in performance exists. Calibrating the model to the fund flows and survivorship rates, we nd these features of the data are consistent with the vast majority (80%) of active managers having at least enough skill to make back their fees.

download in pdf format
   (525 K)

email paper

This paper is available as PDF (525 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w9275

Published: Berk, Jonathan B. and Richard C. Green. "Mutual Fund Flows and Performance in Rational Markets." Journal of Political Economy 112 (2004), 1269-1295.

Users who downloaded this paper also downloaded these:
Chevalier and Ellison w5234 Risk Taking by Mutual Funds as a Response to Incentives
Lehmann and Modest w1721 Mutual Fund Performance Evaluation: A Comparison of Benchmarks and Benchmark Comparisons
Berk and Tonks w13042 Return Persistence and Fund Flows in the Worst Performing Mutual Funds
Chan, Chen, and Lakonishok w7215 On Mutual Fund Investment Styles
Cohen, Frazzini, and Malloy w13121 The Small World of Investing: Board Connections and Mutual Fund Returns
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us