Mutual fund flows and returns dynamics: Investor preferences and performance persistence

We investigate the flow-performance relationship by the lens of the investor preferences, applying a mutual fund dataset with an investment objective focused over European and US area. Incorporating a novel measure of asset managers’ market timing ability, we analyze the role played by performance persistence in mutual fund investing decisions by focusing on top performers in a short-time window. Our empirical results showed that preferences strongly influence the returns-flow dynamics when accounting for the asset type, geographical investment focus, and management style tilt, shedding new light on the behavior of certain clustered groups of investors. Furthermore, we find a long-run information effect as a proxy of a positive association between past returns and flows leading by the smart money effect. Surprisingly, we also observe irrational investors’ behavior when chasing for negative performers, likely due to a herding effect or flow persistent hypothesis as a result of the mechanisms of market allocation efficiency, which is likely to be affected by a slowdown functioning in the short-term phase. Robustness analyses confirm overall results.