Are Mutual Funds Doomed to Underperform? Evidence from Managerial Turnover and Fund Flows

We empirically investigate the impact of fund flows and managerial turnover on the investment performance of active equity mutual funds. Fund flows have been suggested by Berk and Green (2004) as mechanism that prevents performance persistence. We propose managerial turnover as an alternative explanation. One the one hand, withdrawing money from loser funds and sacking bad fund managers are measures of external and internal control in delegated money management, respectively. On the other hand, if winner funds receive excessive inflows or their star manager leaves the fund future performance might deteriorate. Using a sample of 3,948 U. S. equity mutual funds from 1992 to 2007 our results confirm this relationship for both control mechanisms for the cross-section and over time. The performance of top funds strongly suffers from excessive inflows and leaving of the skilled fund manager. Loser funds benefit from a replacement of their apparently unskilled manager but cannot gain from cash outflows to the same degree. Thus, we offer empirical evidence that the managerial turnover channel is at least as important in explaining the lack in performance persistence as funds flows. Furthermore, we show that both channels have a marginal impact on performance which is mutually independent.