Is Mutual Fund Promotion Bittersweet? Evidence from Chinese Mutual Funds

Is Mutual Fund Promotion Bittersweet? Evidence from Chinese Mutual Funds Ping Jiang Associate Professor Department of Finance School of International Trade and Economics University of International Business and Economics Chaoyang, Beijing, China, 100029 Office: (86) 10 6449-3993 Email: ping.jiang@uibe.edu.cn Xueming Luo Eunice & James L. West Distinguished Professor Department of Marketing College of Business Administration The University of Texas at Arlington, Arlington, TX 76019 Office: (817) 272-2279 Email: luoxm@uta.edu Shu Tian Assistant Professor Department of Finance School of Management Fudan Univeristy, Shanghai, China, 200433 Office: (86) 21 2501-1087 Email: stian@fudan.edu.cn April 2012 Abstract From the aspect of investor attention, fund promotion can enhance fund visibility, repeated reference and brand fame. This study tests whether fund promotion is bittersweet to the mutual fund industry, i.e., driving down the abnormal return earned by smart money (dubbed as the smart money erosion hypothesis) on the one hand and enticing fund managers to employ promotion strategies to attract new customers, boost market share, and achieve fund market dominance (dubbed as the market dominance hypothesis) on the other hand. Using a unique and comprehensive dataset of Chinese mutual funds during 2004-2010, we find empirical evidence for both hypotheses. Keywords: marketing finance interface, fund promotion, smart money effect, market dominance, investor attention 1 Is Mutual Fund Promotion Bittersweet? Abstract From the aspect of investor attention, fund promotion can enhance fund visibility, repeated reference and brand fame. This study tests whether fund promotion is bittersweet to the mutual fund industry, i.e., driving down the abnormal return earned by smart money (dubbed as the smart money erosion hypothesis) on the one hand and enticing fund managers to employ promotion strategies to attract new customers, boost market share, and achieve fund market dominance (dubbed as the market dominance hypothesis) on the other hand. Using a unique and comprehensive dataset of Chinese mutual funds during 2004-2010, we find empirical evidence for both hypotheses. Keywords: marketing finance interface, fund promotion, smart money effect, market dominance, investor attention 2 I. Introduction The recent decade has witnessed a booming of the mutual fund industry around the world. By the end of 2004, there were 55,523 mutual funds around the world holding the total net assets of 16.15 trillion USD, which grows to 69,519 by the end of 2010 with according total net assets of 24.70 trillion USD.1 The booming mutual fund industry brings an abundance of investment choices, far more than any investor can carefully consider. When purchasing a mutual fund, investors are faced with a formidable search and selection problem similar to that they encounter in stock buying. As a result, fund managers start to aggressively promote the mutual funds to attract investor attention and entice more potential investors to buy their funds. The increasing importance of fund promotion is not fortuitous, but rather can be understood from the perspective of limited investor attention. Odean (1999) proposes that investors limit their search to stocks that have recently caught their attention when they choose among thousands of possible stocks. Barber and Odean (2008) confirm that individual investors become net buyers of attention-grabbing stocks when they search across many investable options. Thus, according to this stream of research, intensive fund promotion should attract investor attention, provide more convenient access to fund information such as managing team, investment expertise, and historical performance, and induce more fund inflows. As pointed out by Barber and Odean (2008, 787) that “attention is not as scarce a resource for institutional investors as it is for individuals,” fund promotion activities will allow funds to acquire more unsophisticated investors who would not invest in mutual funds 1 See Investment Company Fact Book by Investment Company Institute (2011). 3 without the fund promotion. If so, fund promotion may represent a double-edged sword, with bittersweet implications for the mutual fund industry. More specifically, on the one hand, if fund promotion improves information availability to lay investors and attracts their attention, the mutual fund will acquire more unsophisticated investors who may not have selection ability. As a result, funds with high money inflows may not be funds that will have persistently better future performance because the new fund inflows are less smart. Hence, the smart money effect may be weakened or disappear,2 for which we dubbed as the “smart money erosion hypothesis.” On the other hand, fund promotion can be a darling to fund managers. If it can attract investors’ limited attention and acquire lay investors, then fund managers would rely on fund promotion strategies to acquire new customers and retain existing ones, thus achieving fund market dominance with enlarged investor bases, market share, and net fund flows. We dubbed this as the “market dominance hypothesis” of fund promotion. The goal of our paper is to empirically test these two hypotheses. Consistent with the investor attention perspective, we posit that intensive promotion activities made by a fund management company may render a fund to the consideration investment sets.3 In particular, extensive promotional channels such as banks, brokers, and direct sales center bring repeated reference and greater visibility to potential investors thus attracts their limited attention. Also, 2 Zheng (1999) documents a “smart money effect,” which suggests that the ex ante smart investors invest in funds with good subsequent performance and these investors’ investment choices are informative in predicting subsequent fund performance. 3 In China, mutual funds are affiliated with and operated by a fund management company, which offers multiple funds with different investment styles and targets. Funds affiliated with the same management company can be viewed as a fund complex, and individual funds can be products sharing the same fund management company brand but with different product features. 4 special promotion plans such as discounts on transaction and management fees via certain distribution channels and trading methods, VIP treatment, and free gifts make a fund more attractive and obtain more investor attention. Amongst the many funds sold by the same sales agent, funds with promotions tend to be eye-catching with an “on sale” effect which attracts more attention from investors than funds without promotions. Table 1 lists how various fund promotion activities may attract investor attention, enhance information availability, and, thus, influence investors’ investment behaviors. （Table 1 Here） Empirically, we use a comprehensive and unique dataset of Chinese mutual funds, which have experienced a rapid growth along with the fast development of the world’s largest emerging market nowadays. The data is free from the survivorship bias and contains an all-around set of fund promotion activities. To be specific, it covers fund management companies’ decisions on distribution channels and special promotion plans via which investors can purchase fund shares. In addition, given its growing stage, Chinese mutual fund industry may use fund promotion to effectively attract individual unsophisticated investors. Thus, the data allows for an in-depth testing of the smart money erosion hypothesis and market dominance hypothesis of various fund promotion activities. Our data analyses suggest empirical evidence for the smart money erosion hypothesis. As previous fund flows and promotion may simultaneously determine fund performance, we construct 25 double-sorted portfolios from ranking funds on previous fund flows and fund promotion activities following Sadka and Scherbina (2007). In this way, we examine how performance of fund portfolios can be affected. We show that consistent with Jain and Wu 5 ... - tailieumienphi.vn