Broker Incentives and Mutual Fund Market Segmentation
We study the impact of investor heterogeneity on mutual fund market segmentation. To motivate our empirical analysis, we make two assumptions. First, some investors inherently value broker services. Second, because brokers are only compensated when they sell mutual funds, they have little incentive to recommend funds available at lower cost elsewhere. The need for mutual fund families to internalize broker incentives leads us to predict that the market for mutual funds will be highly segmented, with families targeting either do-it-yourself investors or investors who value broker services, but not both. Using novel distribution channel data, we find strong empirical support for this prediction; only 3.3% of families serve both market segments. We also predict and find strong evidence that mutual funds targeting performance-sensitive, do-it-yourself investors will invest more in portfolio management. Our findings have important implications for the expected relation between mutual fund fees and returns, tests of fund manager ability, and the puzzle of active management. Furthermore, they suggest that changing the way investors compensate brokers will change the nature of competition in the mutual fund industry.
We would like to thank Scott Bauguess, John Campbell, Joseph Chen, Larry Dann, Roger Edelen, Richard Evans, Ro Gutierrez, Edie Hotchkiss, Robert Hunt, Woodrow Johnson, Wayne Mikkelson, Elizabeth Odders-White, Jeff Pontiff, Antoinette Schoar, Phil Strahan, Laurens Swinkels, Peter Tufano, Eric Zitzewitz, and seminar participants at the Pacific Northwest Finance Conference, the Institutional Investors Conference at the University of Texas, Federal Reserve System Conference on Financial Markets & Institutions, 4th One-day Conference on Professional Asset Management at Erasmus University Rotterdam, NBER Summer Institute Household Finance Workshop, Boston College, Cal State Fullerton, INSEAD, Securities and Exchange Commission, Simon Fraser University, University of Arkansas, University of Texas-Dallas, and University of Wisconsin-Madison for helpful comments and discussions. Del Guercio would like to acknowledge support from the Securities Analysis Center at the University of Oregon. We thank Steven Green for excellent research assistance and Deb Wetherbee at Financial Research Corporation for generously providing data on distribution channels. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- Mutual fund families that sell via the direct channel ... outperform comparable funds sold through other distribution channels by 1...