• DOI: 10.1016/j.jfineco.2015.07.003
  • Authors: Ferhat Akbas, Will J. Armstrong, Sorin Sorescu, Avanidhar Subrahmanyam

Key finds

  • Aggregate mutual fund flows (“dumb money”) exacerbate cross-sectional mispricing in US equities, especially in growth, momentum, and accrual anomalies.
  • Hedge fund flows (“smart money”) attenuate mispricing, primarily through short positions in overvalued stocks.
  • Mispricing exacerbation by mutual funds occurs mainly via new investments rather than redemptions.
  • Effects are stronger when mutual/hedge funds have larger market shares.
  • Retail investor flows are the primary source of dumb money.
  • Economic conditions (e.g., Internet bubble run-up) amplify the effects of mutual fund flows on mispricing.
  • Hedge fund flows act intentionally and correct mispricing but do not reverse afterward; mutual fund-induced mispricing tends to revert in 1–3 months.
  • De-trended and orthogonalized analyses confirm robustness; unexpected fund flows drive effects rather than predictable components.

Detail notes

  • Measurement:
    • Mispricing proxy: long–short portfolios based on 11 anomalies from Stambaugh, Yu, and Yuan (2012).
    • Mutual fund flows: CRSP Survivor-Bias-Free US Mutual Fund Database.
    • Hedge fund flows: Lipper TASS database (US equity-focused).
    • Controls: liquidity (AGGILLIQ, AGGTURN), Fama-French three factors (RMRF, HML, SMB), market trends, sentiment, VIX.
  • Methodology:
    • Time-series regressions of long-short returns on fund flows with controls.
    • Decomposition of mutual fund flows into new investment, reinvestment, other inflows, redemptions using SEC N-SAR data.
    • Composite mispricing measures by grouping anomalies (growth/momentum/accrual vs. real investment; old vs. new).
    • Orthogonalization and de-trending to handle trends and autocorrelations.
  • Empirical insights:
    • Mutual fund inflows disproportionately target overvalued growth/accrual stocks (short leg), causing mispricing.
    • Hedge funds exploit these temporary mispricing opportunities, predominantly via short positions in overvalued stocks.
    • Flows to real investment anomalies are largely unaffected.
    • Residual fund flows (unexpected deviations) have stronger effects than predicted flows.
    • Interaction with market share shows larger effect sizes when fund industry share is higher.

Suggestion on how to use the paper (based on the tag area)

  • [alpha][flow]: Use the results to identify periods when “dumb money” inflows likely distort cross-sectional returns, creating arbitrage opportunities for systematic alpha strategies.
  • Incorporate hedge fund flow proxies as potential indicators of mispricing correction for timing short positions in overvalued stocks.
  • For factor research, consider separating growth/accrual vs. real investment anomalies when assessing the impact of aggregate flows.
  • Useful for building predictive signals in equity alpha models that exploit temporary price pressure from mutual fund flows.
  • The methodology provides a template for quantifying smart vs. dumb money impact in other markets or asset classes.