Learning about Mutual Fund Managers

DARWIN CHOI, BIGE KAHRAMAN, and ABHIROOP MUKHERJEE∗

Journal of Finance, forthcoming

ABSTRACT

We study capital allocations to managers with two mutual funds, and show that in-

vestors learn about managers from their performance records. Flows into a fund are

predicted by the manager’s performance in his other fund, especially when he outper-

forms and when signals from the other fund are more useful. In equilibrium, capital

should be allocated such that there is no cross-fund predictability. However, we find

positive predictability, particularly among underperforming funds. Our results are con-

sistent with incomplete learning: while investors move capital in the right direction,

they do not withdraw enough capital when the manager underperforms in his other

fund.
∗
Darwin Choi and Abhiroop Mukherjee are at Hong Kong University of Science and Technology, and Bige
Kahraman is at Saı̈d Business School, University of Oxford. We thank Kenneth Singleton (the Editor), an
Associate Editor, and two anonymous referees for many helpful suggestions. We are also grateful for com-
ments received from Tim Adam, Vikas Agarwal, Nicholas Barberis, Jonathan Berk, Utpal Bhattacharya,
Lauren Cohen, Magnus Dahlquist, Francesco Franzoni, Mariassunta Giannetti, William Goetzmann, Luis
Goncalves-Pinto, Jennifer Huang, Marcin Kacperczyk, Raymond Kan, Dong Lou, Kasper Nielsen, Lubos Pas-
tor, Jonathan Reuter, Mark Seasholes, Paolo Sodini, Laura Starks, Per Stromberg, Mandy Tham, Heather
Tookes, Michaela Verardo, Baolian Wang, Mitch Warachka, Russ Wermers, Youchang Wu, Tong Yao, Hong
Zhang, and Lu Zheng, as well as from seminar participants at American Finance Association Annual Meet-
ing 2014, Rothschild Caesarea Center 11th Annual Conference 2014, China International Conference in
Finance 2013, Recent Advances in Mutual Fund Research 2013, Seventh Singapore International Confer-
ence on Finance 2013, Auckland Finance Meeting 2012, HKUST Finance Symposium 2012, Seventh Annual
Early Career Women in Finance Conference 2012, Curtin University, HKUST, London School of Economics,
Shanghai Advanced Institute of Finance, SIFR/Stockholm School of Economics, and University of West-
ern Australia. We acknowledge the General Research Fund of the Research Grants Council of Hong Kong
(Project Number: 640610) for financial support. We have read the Journal of Finance’s disclosure policy
and have no conflicts of interest to disclose. All errors are our own.
Mutual funds are important investment vehicles for many households. While previous stud-
ies show that investors infer funds’ ability to generate excess future returns from past returns
and allocate their capital accordingly (Sirri and Tufano (1998), Huang, Wei, and Yan (2007,
2012), Franzoni and Schmalz (2015)), some attribute the performance-chasing behavior to
behavioral biases (Frazzini and Lamont (2008), Bailey, Kumar, and Ng (2010)).1 In this pa-
per, we provide evidence that investors learn about mutual fund managers in a sophisticated
manner. Learning about managers is particularly value-relevant as recent empirical research
documents large differences among managers in terms of skill.2 Our paper studies managers
who manage two mutual funds and examines whether investors learn about managerial abil-
ity from past performance in the other fund managed by the same person. Moreover, we
ask whether such learning behavior is, as typically assumed in theoretical models, complete.
Our analysis contributes to the debate on the rationality of investors’ behavior.

We first extend Berk and Green’s (2004) model to a setting with two funds per man-
ager, and derive empirical tests for the flow-performance relationship under fully rational
and frictionless conditions. We find that flows do indeed respond to the other fund’s past
performance in the data, and in ways that are consistent with our model predictions on
learning. Instead of simply suggesting that investors are learning rationally in a frictionless
market, we take an additional step and examine whether the response in flows is “sufficient.”
Superior past performance in one fund signals positive managerial ability. If flows drive down
fund performance due to decreasing returns to scale, sophisticated investors should allocate
more capital into the manager’s other fund, up to the point that it earns zero expected
returns in the future.3 A similar argument applies if one of the manager’s funds performs
poorly. This null hypothesis of no cross-fund predictability, which mirrors Berk and Green’s
(2004) equilibrium, indicates sufficient allocation. However, if investors do not move enough
capital into and out of a fund given the other fund’s performance, there would be positive
predictability, while negative predictability could arise if investors move too much capital in
response to signals.

1
 Our main results are summarized as follows. We find that flows into a fund are predicted
by past performance in both of the manager’s funds. In a linear flow-performance regression,
which includes past four-factor alphas of both funds as independent variables, the sensitivity
to the other fund’s performance is about 17% of the sensitivity to the fund’s own performance.
This result is not explained by the fact that the two funds come from the same family. We
control for family fixed effects and the presence of a star fund, which can create spillover
flows to other funds in the family (Nanda, Wang, and Zheng (2004)). Moreover, consistent
with our model’s predictions, flows respond more to the other fund and less to the fund itself
when the two funds are more similar in style or when the fund has more volatile returns.
Flows also respond less when the manager has been managing the funds longer. Taken
together, these findings suggest that investors draw inferences about managerial ability from
the past returns of both funds. Through a piecewise-linear regression framework, we further
show that the effect of the other fund is more pronounced when its performance has been
exceptionally good.

From the performance predictability tests, we find positive cross-fund predictability,

which indicates that investors do not respond enough to the manager’s performance in his
other fund. We sort all two-fund managers into portfolios based on past performance in one
of their funds. Managers’ future performance in their other funds is examined, with various
holding periods. Our tests show that a manager’s past performance in one fund predicts
future performance in his other fund, a result that is also confirmed by using a double sort
or running a regression, both of which control for past performance in the fund itself. Such
predictability is unlikely to be due to price pressure, as it does not reverse in the long run
(in contrast to the own-fund case; Lou (2012)) and it is not driven by cases in which the
two funds’ portfolios have a high degree of overlap. Rather, it comes mostly from underper-
forming multi-fund managers, which suggests that investors do not withdraw enough money
from a fund when the other fund underperforms. This finding is consistent with our previous
result that investor flows respond more to a manager’s performance in his other fund when

2
it is better.

Although other studies have examined the flow-performance relationship and return pre-
dictability in mutual funds, using two funds from the same manager offers some unique
advantages. First, we provide new evidence on performance-chasing behavior, which may
be rational or related to behavioral biases. As predicted by our model, we find that flows
respond more to past performance in the other fund when the signal is more precise and
relevant, indicating that investors learn in a sophisticated manner. Second, we are able to
identify investor learning at the manager level. Previous studies conducting fund-level anal-
yses typically cannot distinguish between information about the fund and its management.
Our paper contains two sets of “placebo” samples to single out the effect of managers. In
one sample we use the same two funds in a period when they are managed by different man-
agers, while in the other sample we replace one of the manager’s funds with another fund
in the same fund family or with a fund that has similar characteristics but is not managed
by the same manager. Our main results do not obtain using these placebos. Third, our
research design allows us to control for the impact of flow-driven price pressure on perfor-
mance persistence and explore the role of investor learning. There is some return persistence
in mutual funds (Carhart (1997)), but own-fund return persistence is partly attributed to
price pressure arising from fund flows.4 Funds facing outflows liquidate their positions that

are concentrated in losing stocks and drive down future stock returns as well as fund returns
(Lou (2012)). Using two funds from the same manager, we are able to control for past re-
turns in the own fund, which is an important driver of flow-driven price pressure. We are
also able to measure the similarity between the two funds’ portfolios, and thus control for
the role of overlapping positions leading to cross-fund predictability.

This paper contributes to our understanding of mutual fund investor learning. We con-
clude that investors are generally sophisticated – perhaps surprisingly sophisticated in light
of papers that suggest otherwise – and respond in the correct direction. However, capital
flows do not respond to a manager’s overall performance enough. Our model provides a

3
framework similar to Berk and Green (2004) to understand rational learning about man-
agers who manage two funds, and is only partially supported by the data. We also present
a simple extension of the model that allows for frictions. Three possible types of frictions
are discussed: (i) institutional frictions (such as loads), (ii) costly information acquisition,
and (iii) investors underweighting new information on their manager. We provide evidence
that the first channel is not the only driving mechanism, while channels (ii) and (iii) result
in investors’ overweighting priors and can potentially explain our overall findings.

Our paper complements other studies on cross-fund learning. Cohen, Coval, and Pastor
(2005) propose a performance measure based on the historical returns and holdings of many
other funds. However, flows do not seem to respond to their measure, perhaps because
aggregating all the information across funds is too complex for a typical investor.5 Using the
variability in fund alphas, Jones and Shanken (2005) generate a precision-weighted average
measure of fund performance that seems to have some effects on capital allocation. A
contemporaneous paper by Brown and Wu (2016) develops a model of optimal cross-fund
learning within fund families and tests the impact of family performance on flows. They
argue that there are two opposite impacts, a positive common skill effect and a negative
correlated noise effect, and that the first effect typically dominates. While our results on the
flow-performance relationship are generally consistent with Brown and Wu’s (2016) model,
our focus is on cases in which two funds are managed by the same person. We find that
manager skill is important and is different from family-specific or industry-wide information.
More specifically, common management appears to be the main source of the “common
skill” effect within fund families. Another major distinction between our paper and other
studies is that we also examine the magnitude of the response. In particular, we complement
prior literature by showing that although the response in flows is in the right direction, it
is not always sufficient. We therefore offer a conclusion that is different from prior studies.
Brown and Wu (2016), for example, do not examine predictability and present no evidence
suggesting anything other than a fully rational and frictionless world.

4
 Other related papers include Franzoni and Schmalz (2015), who model Bayesian investors’
learning behavior under uncertainty about funds’ risk loadings and show that flows are more
sensitive to performance when market returns are moderate than when they are very high
or low; Huang, Wei, and Yan (2012), who show that flow-performance sensitivity is weaker
for funds with more volatile past performance and longer track records; and Yadav (2010)
and Agarwal, Ma, and Mullally (2015), who also look at multi-fund managers, but study
managers’ incentives and the determinants of multitasking.

The remainder of this paper is structured as follows. Section I extends Berk and Green’s
(2004) model to a two-fund manager setting, derives the empirical predictions, and discusses
potential reasons for insufficient capital allocation. Section II describes our sample. Sections
III and IV present results for our central hypotheses on performance-chasing and predictabil-
ity, respectively. Section V concludes. Appendix A provides proofs, Appendix B contains a
simple extension to the model, and Appendix C outlines the procedures for constructing a
placebo sample.

I. A Model of Managers With Two Funds

A. The Cross-Fund Flow-Performance Relationship

We extend Berk and Green’s (2004) fully rational expectations model to accommodate
a context in which each fund manager manages two funds simultaneously. Managers differ
in their ability to generate returns in excess of a passive benchmark. Investors observe past
returns of the two funds and attempt to infer their manager’s ability. A manager’s excess
returns over the benchmark, before fees, for his Funds 1 and 2 at time t are given by

5
 ⎡ ⎤ ⎡ ⎤
⎢R1t ⎥ ⎢ψ1 + 1t ⎥
Rt ≡ ⎣ ⎦ = ⎣ ⎦, (1)
R2t ψ2 + 2t

where ψi s, funds’ expected excess returns, are partly fund-specific and partly manager-
specific, that is, a manager can generate excess returns, but not necessarily by the same
amount in the two funds (ψ1 generally does not equal ψ2 ).6 While we do not model the source
of these excess returns, we believe that managers could possess stock-picking and market-
timing ability (Berk and Green (2004), Mamaysky, Spiegel, and Zhang (2008), Kacperczyk,
van Nieuwerburgh, and Veldkamp (2014)) and that part of the two funds’ excess returns
can be attributed to the manager. Throughout the paper, we define the unobserved ability
to generate expected (gross) returns in excess of a passive benchmark in the two funds as
manager skill. Such returns are the abnormal gross returns that investors can earn from
their perspective, as in Berk and Green (2004) and Pastor, Stambaugh, and Taylor (2015).7
The idiosyncratic errors, it s, are normally distributed with mean zero and can be diversified
away by investing in many different funds. We assume that 1t and 2t are uncorrelated.8

Denote the size of Fund i (i = 1, 2) at time t as qit , and the costs of management as
C(qit ), which is a function of size. Assume that managers earn a fixed management fee, f ,
expressed as a fraction of the fund size.9 The excess total payout to investors of fund i, net
of fees and costs, at time t + 1 is

T Pi,t+1 = qit Ri,t+1 − C(qit ) − qit f. (2)

As in Berk and Green (2004), the costs of management are increasing and convex (C  (q) > 0
and C  (q) > 0) as funds face decreasing returns to scale. They argue that decreasing returns
to scale arise because, for a larger fund, trades might be associated with a higher price impact
or execution costs, and the information-gathering activities might be spread thinner. For
simplicity, we assume that there are no cost externalities from one fund to another (i.e., for

6
Fund 1, C(q1t ) depends on q1t but not on q2t , and vice versa). The excess net return to
investors of fund i is therefore equal to

T Pi,t+1
ri,t+1 = = Ri,t+1 − c(qit ),
qit
⎡ ⎤
⎢c(q1t )⎥
that is, rt+1 = Rt+1 − ⎣ ⎦, (3)
c(q2t )

C(qit )
where c(qit ) ≡ qit
+ f is the unit cost associated with investing in Fund i at time t.

Investors are Bayesians and observe historical returns Rt (which they infer from excess net
return rt in equation (3)) from t = 1, . . . , T . The returns Rt are drawn from a multivariate

normal distribution with unknown mean μ = ψψ12 (from equation (1)) and known variance-

covariance matrix Ω = V01 V02 . That is,

⎡ ⎤
⎢ ψ1 ⎥
Rt ∼ N (⎣ ⎦ ; Ω). (4)
ψ2

Let investors’ priors on ψi s at time 0 be

⎡ ⎤
⎢ψ10 ⎥
⎣ ⎦ ∼ N (μ0 ; Σ0 ), (5)
ψ20


where Σ0 ≡ W1 W12
W12 W2 , with W12 capturing the covariance between ψ10 and ψ20 . This
represents investors’ beliefs on the extent to which the manager’s ability can be carried from
one fund to the other. We define the following precision matrices: S ≡ Ω−1 and P0 ≡ Σ0 −1 .

In the absence of frictions, investors should invest more money into funds that earn
positive expected excess net returns (in the next period), and withdraw from funds that
earn negative expected excess net returns. Given that there are decreasing returns to scale,
investors competitively allocate capital to funds up to the point that all funds earn zero

7
expected excess net returns (as in Berk and Green’s (2004) equilibrium). Therefore, from
the investor’s perspective, which is conditioned on the information set available at time T ,

ET [ri,T +1 ] = 0 (6)

for all managers and all funds. In our fully rational and frictionless baseline model in this
section, the conditioning information at time T is complete and the probability measures
of investors are rational. This learning environment is the same as that in Berk and Green
(2004). Appendix B presents an extension where the investor’s expectation operator is
different from the “true” expectation operator.

From equation (3), we have

⎡ ⎤
⎢c(q1T )⎥
ET [RT +1 ] = ⎣ ⎦. (7)
c(q2T )

Denote investors’ expected excess gross fund returns, given information at time T , as μT .
We then have ⎡ ⎤
⎢c(q1T )⎥
μT ≡ ET [RT +1 ] = ⎣ ⎦. (8)
c(q2T )

 ψ1
We now specify the process by which investors update their beliefs on ψ2 , the two
funds’ ability to beat the benchmark (recall that the ability is partly due to the manager).

From equations (4) and (5), both the signal Rt and the prior ψψ10 20
follow a multivariate
normal distribution. Applying Theorem 1 from DeGroot (2004, p.175), the mean of the
posterior distribution of the manager’s ability to beat the benchmark at time T is given by

μT = [P0 + T S]−1 [P0 μ0 + T SRT ], (9)

where RT is the arithmetic mean of R1 , R2 , . . . , RT . This updating rule states that the

8
posterior mean depends on the mean of the priors at time 0, the precisions of the signals
and the priors, the number of periods, and the average excess gross return. This Bayesian
updating yields the following equation (see Appendix A for the derivation):

μT = μT −1 + [P0 + T S]−1 SrT . (10)

In equilibrium, the posterior mean depends on the mean at time T − 1, the precisions of the
signals and the priors, the number of periods, and the excess net return at time T . When the
excess net return is positive (negative), the posterior mean is revised upward (downward)
from the mean at time T − 1.

We are interested in investors’ flows into and out of Funds 1 and 2. In our context, we
examine the change in the size of the funds, qiT − qi,T −1 . Since the unit cost function c is
monotonically increasing in qit , it suffices to look at the change in the unit cost, c(qiT ) −
c(qi,T −1 ).10 From equations (8) and (10),

⎡ ⎤
⎢c(q1T ) − c(q1,T −1 )⎥ −1
⎣ ⎦ = μT − μT −1 = [P0 + T S] SrT . (11)
c(q2T ) − c(q2,T −1 )

We derive the following equation for Fund 1 in Appendix A:

c(q1T ) − c(q1,T −1 ) = A1 r1T + A2 r2T , (12)

Td
d W1 + V2
where A1 = ,
Δ V1
d W12
A2 = ,
Δ V2
2
d = W1 W2 − W12 ,
T 2 d2 W 1 W2
Δ=d+ + T d( + ).
V1 V2 V1 V2

9
 We formally introduce a proposition about the flow-performance relationship, as cap-
tured by A1 and A2 , the coefficients of excess net returns in equation (12).11 Proofs of all
propositions are presented in Appendix A.

PROPOSITION 1: Flows are always increasing in the fund’s past excess return; flows are
increasing in the other fund’s past excess return, as long as W12 is positive.

Intuitively, flows chase past performance in the fund, as it signals the fund’s ability
to beat the benchmark. If managerial skill carries over from one fund to another (W12
is positive), then good past performance in the other fund is also a positive signal of the
manager’s ability, and flows chase past performance in the other fund as well. The relative
W1 + T
V
d
W12
2
size of the two coefficients, A1 and A2 , also depends on W12 : if V1
> V2
, then A1 > A2 .
In other words, if W12 is below a certain threshold, then investors respond more strongly
to the fund’s past performance than to the other fund’s, as the latter is less relevant. We
discuss the relative size of these coefficients in Section III.A.

B. Cross-Sectional Predictions

In this section, we develop a few more testable propositions by examining how A1 and
A2 change with some parameters in the model. These propositions help us understand when
the flow-performance relationship should be stronger in the cross-section of managers.

PROPOSITION 2: If W12 is higher, then flows respond more to the other fund’s past excess
return, and less to the own fund’s past excess return.

This means that when skill is less transferable across funds (W12 is lower), the other
fund’s performance becomes less relevant and investors naturally have to depend more on
the fund itself to infer their future prospects. If skill is more transferable across funds, then
the coefficients go in opposite directions.

10
PROPOSITION 3: If the signal from the own fund return is noisier, then flows respond
more to the other fund’s past excess return and less to the own fund’s past excess return. If
the signal from the other fund return is noisier, then flows respond more to the own fund’s
past excess return and less to the other fund’s past excess return.

Higher volatility makes investors less certain that a positive excess return is due to skill,
and therefore investors rationally put lower weight on more volatile fund returns. As before,
similar logic applies: the reduced relevance of one signal makes investors depend more on
the other, ceteris paribus.

PROPOSITION 4: If the manager has been managing the two funds for a longer period
of time, then flows respond less to both the own fund’s past excess return and the other
fund’s past excess return.

Finally, if T is larger (the manager has been managing the two funds for more time),
then investors have already learned more about the manager’s ability using past signals and
hence react less to the most recent excess returns of the two funds.

These predictions are unlikely to be explained by some types of crude trend-chasing

behavior, under which we expect investors to simply chase past returns in both funds (sen-
sitivities do not vary with the parameters). We test the above propositions in Section III.

C. Extension: Frictions in Capital Allocation

In the baseline model, we present a fully rational and frictionless equilibrium that is
similar to Berk and Green (2004). Note that the equilibrium condition in the model implies
that the manager’s two funds should earn zero expected excess net return from the investor’s
perspective (equation (6)). In Appendix B, we extend our model to account for frictions.

11
 Specifically, we describe three possible channels: institutional frictions, informational
frictions, and behavioral frictions. First, in the presence of transactions costs such as front-
end and back-end loads imposed by institutions, investors may choose not to react to new
signals because they find it more costly to move capital across different funds. Second,
information (fund performance) may not be accessible to investors at zero cost. The cost
of acquiring information can be the time and effort required to find out how funds have
performed, that is, “observation costs,” as in Duffie and Sun (1990), Gabaix and Laibson
(2005), Abel, Eberly, and Panageas (2007), and Alvarez, Guiso, and Lippi (2012). As a
result, investors would not be able to obtain new information on a continuous basis. Finally,
investors may suffer from conservatism (Edwards (1968), Barberis, Shleifer, and Vishny
(1998), Choi and Hui (2014)), relying too much on priors. All these channels might make
investors place too much weight on priors and too little weight on new information, relative
to a Bayesian operating in a frictionless world (our baseline model).

To model this, we start from equation (10),

μT = μT −1 + [P0 + T S]−1 S[RT − μT −1 ] , from equations (3) and (8)

= {I − [P0 + T S]−1 S}μT −1 + [P0 + T S]−1 SRT

= {I − M }μT −1 + M RT , (13)

where M = [P0 + T S]−1 S. If investors overweight priors and underweight new information,
we can modify equation (13) as follows:

μIT = {I − kM }μIT −1 + kM RT , (14)

where μIT is the expected gross fund return under investors’ beliefs and information, and
0 < k < 1.12

Our extension in Appendix B demonstrates that if investors use equation (14) to update

12
their beliefs, then flows into a fund will be less responsive to the other fund’s past excess
return. As a result, the excess return of one fund will positively predict the other fund’s
expected future performance, unlike in the rational and frictionless equilibrium. However,
the model extension demonstrates that cross-sectional predictions from our baseline model
remain valid, even in the presence of frictions.

From the modeling perspective, we do not distinguish between the three types of fric-
tions. Brav and Heaton (2002) show that a learning model with behavioral biases (such as
conservatism) looks mathematically very similar to a learning model with incomplete infor-
mation, which makes it hard to distinguish between the two. We investigate the empirical
evidence regarding frictions in Section IV.C.

II. Data Sources and Sample

We primarily use the Center for Research in Security Prices (CRSP) Survivorship Bias
Free Mutual Fund Database. The CRSP mutual fund database includes information on
fund returns, total net assets (TNA), fees, and other fund characteristics such as managers’
names. However, a large panel of multi-fund managers is not readily available because the
names CRSP provides are not recorded consistently over time and across funds: first and
middle names are sometimes abbreviated differently and are sometimes excluded. We track
all managers carefully and hand-construct our database of multi-fund managers taking into
account spelling differences and format changes, similar to, for example, Kacperzyk and
Seru (2007). Sometimes the names do not match perfectly. We apply our best judgment by
first looking up publicly available information on funds from the Internet, and then, if this
information is not available, by estimating how common the names are (e.g., common last
names are more likely to refer to different people). We analyze all names that are available
in CRSP and drop funds with missing managers’ names. From the CRSP data we are able

13
to identify 9,596 distinct managers.

We focus on funds that are managed by a single person who manages more than one
fund. We exclude funds managed by two or more people because team-managed and solo-
managed funds have different organizational structures (Chen et al. (2004)), and we do not
know how responsibilities are divided among team managers. Following Agarwal, Ma, and
Mullally (2015), we also exclude cases in which a manager runs more than four funds, as
these managers are likely to be team managers.

To be consistent with other recent papers in the literature, our analysis uses a subset of
funds in the CRSP database. We examine funds with the investment objectives of growth and
income, growth, and aggressive growth. These objectives are identified by the investment
objective codes from the Thomson-Reuters Mutual Fund Holdings database.13 We only

include funds that invest more than half of their assets in common stocks. Finally, we
exclude index funds (funds that are identified by CRSP as index funds or funds that have
the word “index” in their reported fund names), as well as funds that are closed to new
investors.

During our sample period, many funds have multiple share classes. Since each share
class of a fund has the same portfolio holdings, we aggregate observations to the fund level,
following Kacperczyk, Sialm, and Zheng (2008). For qualitative attributes such as objective
and year of origination, we use the observation of the oldest class. For the TNA under
management, we sum the TNAs of all share classes. We take the lagged TNA-weighted
average for the rest of the quantitative attributes (e.g., returns, alphas, and expenses).

Data on managers’ names from CRSP are available starting in 1992.14 Our sample

covers the period 1992 to 2012. The fraction of managers that manage more than one
fund in our sample is 27%, and these managers manage 30% of the total assets in domestic
equity actively managed mutual funds. In the data we construct from CRSP, a multi-fund
manager typically manages two open-end mutual funds for four years. While our paper does

14
not study how mutual fund managers become multi-fund managers or managers’ incentives,
Agarwal, Ma, and Mullally (2015) report that these managers are usually more experienced
and have performed well in the past, after which they either start new funds or take over
other funds within the same fund company. Agarwal, Ma, and Mullally (2015) further
find evidence of performance deterioration in the old funds they have been managing and
performance improvement in the acquired funds, suggesting a potential agency problem.
Yadav (2010) shows that star funds can result in investors’ flows into other funds managed
by the same manager, and managers have an incentive to create different portfolios to increase
the likelihood of generating a star fund.

Although we do not analyze the emergence of multi-fund managers in the market, we

discuss a few potential explanations. First, companies may use additional funds to retain
good managers; there is already evidence of this in other parts of the fund industry. For
example, star mutual fund managers can manage hedge funds side-by-side (Nohel, Wang,
and Zheng (2010), Deuskar et al. (2011)), and well-performing closed-end fund managers are
sometimes given an additional fund to manage (Wu, Wermers, and Zechner (2015)). Second,
using existing managers can help fund companies overcome labor market frictions in the form
of asymmetric information, as companies are better informed about current managers than
new hires (Berk, van Binsbergen, and Liu (2014)). Third, smaller organizations with fewer
employees work more efficiently if information is “soft” and cannot be credibly transmitted
(Stein (2002), Chen et al. (2004)), so some fund companies simply assign one of the existing
managers to a new fund instead of hiring a new manager.

To test the model in Section I, we randomly pick two funds from each multi-fund manager,
but our results are mostly unchanged if we restrict our analysis to managers who only have
two funds (see Internet Appendix Table IA.III; note that most multi-fund managers, about
85% in our data, have two mutual funds only). After a manager starts managing a fund, we
require at least six months of data on past monthly returns during his tenure to estimate
his performance. In the end, we have 19,538 fund-month observations in our baseline flow-

15
performance regression. Insert
Table I
Table I reports summary statistics on the main attributes of multi-funds in our sample
(Panel A) and of funds that are managed by single-fund managers (Panel B). Single-fund
managers are defined as managers who manage only one fund. We report summary statistics
on fund flow, performance and risk measures, age, TNA, total expense, and total family
TNA. As evident from Table I, funds managed by multi-fund managers do not appear to be
materially different from funds managed by single-fund managers: average flows into these
two types of funds are 0.5% per month, average alphas are −2 to −7 bps per month, and
average total expenses are 1.5% per year; fund age (median ln(Age) is 2.5), size (median
ln(F undSize in $ millions) is 5.5 to 5.8), and family size (median ln(F amilySize in $
millions) is 8.9 to 9.4) are all similar. As the number of funds a manager manages is not
exogenous, we do not claim that our sample of multi-fund managers’ funds is the same as the
remaining part of the U.S. equity mutual fund universe. Nevertheless, multi-fund managers
make up a sizable part of the industry, and we believe that they provide an interesting setting
to study investors’ capital allocation decisions, as discussed in the introduction. Insert
Table II
Table II compares the two funds of multi-fund managers, Funds 1 and 2, which are as-
signed without specific regard to their age and other characteristics. Average characteristics
such as alpha, standard deviation of return, age, size, total expense, and loadings on the
Carhart (1997) factors are similar across the two groups.15

III. Results: Cross-Fund Flow-Performance

Relationship

We test the model’s predictions in this section. Section III.A presents the empirical
results of flow-performance regressions. After showing that the response is consistent with
investor sophistication in Section III.B, we conduct robustness tests in Section III.C. These

16
tests confirm that our results are not picking up market- or industry-wide effects that affect
mutual fund flows generally, or investor learning from other (i.e., different-manager) funds
(as documented by Cohen, Coval, and Pastor (2005), Jones and Shanken (2005), Brown and
Wu (2016)).

A. Flow-Performance Regressions

The dependent variable in our first set of regressions, F lowit , is the proportional growth
in total net assets (T N Ait ) under management for fund i between the beginning and the end
of month t, net of internal growth Rit , assuming reinvestment of dividends and distributions:

T N Ait − T N Ai,t−1 (1 + Rit )

F lowit = .
T N Ai,t−1

We follow standard practice in the literature and winsorize the top and bottom 2.5% tails
of the net flow variable to remove errors associated with mutual fund mergers and splits, as
documented by Elton, Gruber, and Blake (2001).16

We measure fund performance using the four-factor alpha (Alphait ). While there are
obviously other measures of performance, risk- or style-adjusted returns are preferred over
raw returns because two funds managed by the same manager often have different objectives.
Consistent with our model’s predictions being based on excess (benchmark-adjusted) returns,
our empirical analysis focuses on differences in fund performance that are not simply a result
of differences in their styles or objectives. The four-factor alpha is the risk-adjusted return
over the preceding 12 months estimated using the Carhart (1997) four-factor model (we
suppress the subscript t; the regression is run for every 12-month window). A 12-month
window is chosen with the consideration that multi-fund managers typically manage the two
funds over a period of four years.

17
 Operationally, Alphait is the intercept (αi ) in the following regression:

rit − rf t = αi + βi,M KT M KTt + βi,SM B SM Bt + βi,HM L HM Lt + βi,U M D U M Dt + it .

In the first set of tests, we run a flow-performance regression that is motivated by equation
(12) in Section I. The dependent variable in the regression is monthly flows into one of the
funds of a multi-fund manager, F lowt (subscripts i are dropped for brevity). Our main
coefficient of interest is the lagged performance in the manager’s other fund (Alpha2t−1 ),
controlling for the lagged performance in the own fund (Alphat−1 ).17 We include a number of
control variables in our analysis. These include a measure of fund age (ln(Aget−1 )) calculated
as the natural logarithm of (1 + fund age), lagged fund size (ln(F undSizet−1 )) measured
as the natural logarithm of fund TNA, lagged total expense (Expenset−1 ) calculated as the
sum of the expense ratio plus one-seventh of the front-end load, a measure of the total risk
of a fund calculated as the standard deviation of fund raw returns over the preceding 12
months (Stdrett−1 ), the contemporaneous total flows into the corresponding fund objective
(ObjF lowt ), and year-month fixed effects. We also control for flows over the preceding five
months, since monthly flows are predicted by past fund performance as well as past monthly
flows (e.g., Coval and Stafford (2007)). Our baseline regression specification is as follows:18

F lowt = α + β1 Alphat−1 + β2 Alpha2t−1

+ β3 ln(Aget−1 ) + β4 ln(F undSizet−1 ) + β5 Expenset−1

t−1
+ β6 Stdrett−1 + β7 ObjF lowt + βs F lows
s=t−5

+ βx YearMonthFixedEffects x + t . (15)
x

We use both funds of a multi-fund manager in the flow-performance regressions. In the

sample there are two funds for any given manager and month. These are counted as two

18
observations. For example, in one observation we study the flow into one fund (say, F1) and
the performance of the other fund (say, F2) of the manager, while in another observation
F2 becomes the fund in question and F1 becomes the “other fund.” We address concerns
regarding correlations between error terms by clustering standard errors in the regressions
at the manager level.19 Insert
Table
Table III reports the regression results (subscripts t and t − 1 are dropped for brevity).
III
Column (1) supports Proposition 1: both Alpha and Alpha2 are positive and significant.
The results are consistent with our model, which holds that investors learn about managerial
ability from past performance in the fund as well as in the manager’s other fund. The
magnitude of the coefficient on Alpha2 is about 17% of that on Alpha. Increasing Alpha
by one standard deviation increases flows by 0.38% (of TNA) per month, while the same
increase in Alpha2 increases flows by 0.06% (of TNA) per month. We noted in Section I.A
that if W12 is lower than a certain threshold, then investors should react more strongly to
the fund itself than to the other fund. The results here may be explained by this, but may
also be explained by investors’ insufficient response to the other fund; we explore the latter
possibility in Section IV.

The next column runs the same regression, but adds interactive terms between Alpha
and ln(Age) and between Alpha and Stdret (as in Huang, Wei, and Yan (2007, 2012)). The
results are similar. Note that in Column (2), the coefficients on Alpha and Alpha2 are not
directly comparable in the presence of the interactive terms.

Our theoretical model predicts a linear relationship between flows and performance.
However, Huang, Wei, and Yan (2007) show that participation costs generate a convex
relationship. To empirically allow for different flow-performance sensitivities at different lev-
els of performance, we employ the piecewise linear specification of Sirri and Tufano (1998)
in Columns (3) and (4). For each fund i in month t, we assign a fractional performance
rank (Rankit ) that ranges from zero (poorest performance) to one (best performance) ac-

19
cording to its past 12-month four-factor alpha, relative to all funds in the same month.
We then define three variables according to Rankit : the lowest performance quintile is
Low Alphait = Min(Rankit , 0.2), the three medium performance quintiles are grouped to-
gether as M id Alphait = Min(0.6, Rankit − Low Alphait ), and the top performance quintile
is High Alphait = Rankit − M id Alphait − Low Alphait . This regression specification is
similar to equation (15), except that the performance measures are now represented by
the quintile variables: Alpha in equation (15) is replaced by three independent variables,
Low Alpha, M id Alpha, and High Alpha, based on lagged performance in the correspond-
ing fund, and Alpha2 is replaced by three independent variables, Low Alpha2, M id Alpha2,
and High Alpha2, based on lagged performance in the manager’s other fund.20 Column (3)
suggests that flows into a fund are positively related to the fund’s own past performance in
all quintiles. The strongest effect is observed in the highest-performing group.

The Alpha2 variables in Column (3) are all weaker than the corresponding Alpha vari-
ables. Only High Alpha2 is statistically significant. Our results are therefore more promi-
nent when the performance in the other fund is in the top quintile, perhaps because mutual
fund managers or companies make high-performing funds more visible to investors and in-
vestors pay more attention to these funds. When we examine the magnitude of the effect, the
coefficient on High Alpha2 is 49% of that on High Alpha (i.e., when the fund in question

is in the top quintile), which is considerably higher than the ratio in the linear regression in
Column (1). As such, if both funds of the same manager are performing very well, investors’
flows into a fund are relatively more sensitive to the performance in both funds. Moving
Alpha 10 percentiles in the highest performance group, say, from the 85th to the 95th per-
centile, corresponds to a greater inflow of 0.39% (of TNA) per month, while the same change
in Alpha2 is associated with a greater inflow of 0.19% (of TNA) per month. The last column
adds manager fixed effects as extra control variables. The results are similar: High Alpha2
remains statistically significant, while Low Alpha2 and M id Alpha2 are still insignificant.

While Columns (1) to (4) already control for the total flows into the corresponding

20
objective of the fund (ObjF low), we further address potential effects of investors’ style-
chasing by examining an alternative flow measure. We define objective-adjusted flows as flows
into the fund minus the average flows into the corresponding objective of the fund. Columns
(5) to (8) repeat Columns (1) to (4) using objective-adjusted flows as the dependent variable
(ObjF low is removed from the list of independent variables). Our conclusions remain the
same, so style-chasing does not explain our results.21

B. Cross-Sectional Results

If investors are learning about managers’ ability in a sophisticated manner, flows should
be more responsive to the other fund in situations in which the signal provided by the other
fund is more relevant and useful. Four predictions are formalized in Section I.B. We expect
that investors learn more from the other fund and less from the own fund when (i) excess
returns are more transferable across funds (Proposition 2), (ii) the signal from the own-fund
return is noisier (Proposition 3), and (iii) the signal from the other-fund return is more
precise (Proposition 3). We also expect flows to be less sensitive to past performance in
both funds when (iv) the manager has been managing the funds for a longer period of time
(Proposition 4).

To measure the transferability of skill across funds (W12 in equation (5)), we calculate
StyleDifference as follows:

β1,M KT β1,SM B β1,HM L β1,U M D

StyleDifference = abs( − 1) + abs( − 1) + abs( − 1) + abs( − 1),
β2,M KT β2,SM B β2,HM L β2,U M D

where β1,X and β2,X are the two funds’ loadings on the Carhart (1997) factors estimated over
the past 12 months. The variable StyleDifference captures the difference in factor loadings.

We believe that W12 depends on this difference. For example, if a manager has a large-
value fund and a small-growth fund, skill shown in one fund is less likely to be carried to the

21
other fund. For the volatility of the signal from fund returns (V1 and V2 in equation (4)), we
use the standard deviation of fund raw returns in the preceding 12 months (Stdret). We then
define a set of dummy variables: StyleRank, which equals one when StyleDifference is above
the median based on all historical records up to the current month; V olRank (V ol2Rank),
which equals one when Stdret of the fund (of the other fund) is above the sample median in
the corresponding month; and T imeM anageRank, which equals one for the latter half of the
manager’s tenure in the corresponding fund pair.22 We interact these dummy variables with
performance measures in the own fund and in the other fund, and run the flow-performance
regression (equation (15)). Insert
Table
Column (1) of Table IV shows that the coefficient on Alpha2 is significant at 1% level,
IV
but if StyleDifference is above the historical median (i.e., StyleRank = 1), the effect of
Alpha2 becomes significantly weaker and is close to zero while the effect of Alpha becomes
even stronger. Column (2) attempts to control for both style and volatility. One concern is
that volatile fund returns may yield noisy beta estimates, thereby leading to a mechanically
higher StyleDifference. We address this concern by introducing another dummy variable
that controls for high volatility in the two funds. In every month, we rank all managers
on whether they have at least one fund that is more volatile than the sample median (i.e.,
V olRank = 1 or V ol2Rank = 1) and note the median multi-fund manager. The dummy
variable OneV olatileF und then equals one if the manager ranks above this median manager
in the month. The results of the StyleRank interaction variables in Column (2) are similar
to those in Column (1), suggesting that style and volatility have different impacts on the
coefficients of Alpha and Alpha2. These results support Proposition 2.

As predicted by Proposition 3, in Column (3) Alpha2 is significantly stronger and Alpha

is significantly weaker if Stdret is above the median, that is, V olRank = 1. In Column
(4), the interaction terms Alpha × V ol2Rank and Alpha2 × V ol2Rank are introduced in
the regression. The interactions involving V olRank (from the own fund) are statistically
significant, but those involving V ol2Rank (from the other fund) are insignificant. Consistent

22
with the results from Table III (that is, investors use signals from the other fund only when
performance is high), investors do not seem to always fully use information from the other
fund. Finally, Column (5) supports Proposition 4. Both own-fund and cross-fund flow-
performance relationships are significantly weaker in the second half of the manager’s tenure
in the fund pair.

Taken together, Tables III and IV suggest that the flow-performance relationship in
multi-funds arises largely from investor sophistication: mutual fund investors seem to draw
inferences about a manager’s skill from the other fund’s past performance, particularly when
it provides more information. These findings are unlikely to be explained by a behavioral
bias such as trend-chasing; in such a case, we would not expect the effects of Alpha and
Alpha2 to vary in a systematic manner as predicted by our model.

C. Robustness: Family Effects and Placebo Tests

The significance of the coefficients on the Alpha2 variables may be attributed to family
effects, since the two funds of multi-fund managers belong to the same fund family. In Table
V we address this concern by controlling for information from the family. Brown and Wu
(2016) find two opposite effects of family performance: a positive common skill effect and
a negative correlated noise effect. Their results are similar in spirit to ours: their proxy for
the common skill component is the average management overlap rate between the fund and
other funds in the family. In their sample, Brown and Wu (2016) show that their proxy
for the common skill effect dominates on average. In Column (1), we omit Alpha2 from
the regression but include the family average alpha (F amilyAlpha, excluding the fund in
question but including the manager’s other fund) as an independent variable. The coefficient
on F amilyAlpha is positive and significant, consistent with Brown and Wu (2016). Insert
Table V
In Column (2), we include Alpha2 as an additional independent variable and define
F amilyAlpha as the average family alpha excluding the two funds managed by the manager.

23
Column (3) introduces an extra dummy variable that represents stellar performance (top 5%
based on past alpha) of other funds in the family, following Nanda, Wang, and Zheng (2004).
Nanda, Wang, and Zheng (2004) find that stellar performance can create a spillover effect
that increases inflows into other funds in the family. Column (4) further includes family fixed
effects to control for time-invariant unobservable family characteristics. The results in all
three columns are generally unaffected by these additional control variables: the coefficients
on Alpha2 are statistically significant, similar to Table III.

An interesting observation is that F amilyAlpha is negative and significant in Columns

(2) to (4). Using managers who manage two funds, our test allows us to better understand
the different aspects of the common skill effect, namely, common management (i.e., manager)
and availability of resources at the family level (e.g., access to common resources such as
research analysts and brokers). We find that the average family alpha (excluding the two
funds managed by the manager) has a negative impact on fund flows. Our evidence therefore
suggests that, after controlling for the performance in the manager’s other fund, the positive
common skill effect of other funds in the family is dominated by negative effects such as
correlated noise.

We further distinguish between manager and family effects in two “placebo tests” that
also control for market-wide events or other factors that may impact funds with similar
characteristics. The first placebo test examines the two funds in a period when they are
managed by different managers. Suppose that a multi-fund manager manages the two funds
during the time interval [ta , tb ], while the two funds exist and are managed by different people

outside the interval. We examine the periods [ta − 24, ta − 12] and [tb + 12, tb + 24]. We skip
12 months before ta and 12 months after tb with the consideration of our alpha estimation. If
flows chase past performance because of other common factors impacting the two funds, then
we would still see a positive relationship between flows and the Alpha2 variables. However,
Table VI Columns (1) and (2) show that this is not the case. In Column (1), the coefficient on
Alpha2 is marginally significant but negative (consistent with the result of F amilyAlpha in

24
Table V, as these fund pairs are in the same fund family). In Column (2), the coefficients on
the Alpha2 variables are statistically indistinguishable from zero in all performance quintiles. Insert
Table
Second, we make use of control funds, matching on characteristics that matter for flows.
VI
Let F1 be the fund in question and F2 be the other fund. We then find a control fund,
M2, to match F2. Our matching algorithm, much like the commonly used stock-matching
algorithm employed in Loughran and Ritter (1997), finds the “nearest fund.” The procedure
is outlined in Appendix C. We use the same M2 throughout the manager’s tenure in the
two funds. The idea is to choose a fund within the family and/or of similar size with the
most similar average characteristics (based on the independent variables in the baseline
flow-performance regression, equation (15)). Table VI Columns (3) and (4) repeat Table
III Columns (1) and (3), replacing the Alpha2 (i.e., four-factor alpha of F2) variables with
variables based on the four-factor alpha of M2. If our previous results are mostly due to
investors’ learning about the multi-fund manager, flows into F1 should not respond to the
past performance of M2. The results in this placebo test are in line with our expectation, as
none of the variables (Alpha2 in Column (3); Low Alpha2, M id Alpha2, and High Alpha2
in Column (4)) are significant.

Overall, this section shows that mutual fund investors chase performance in the direction
predicted by our model.

IV. Results: Cross-Fund Return Predictability

Our next question is whether there is any cross-fund return predictability: can one fund’s
return predict subsequent performance in the other fund? Such predictability would be
indicated if investors systematically move too little (positive predictability) or too much
(negative predictability) capital across funds relative to our frictionless rational benchmark.
This research question differentiates our paper from other studies on cross-fund learning,

25
such as Cohen, Coval, and Pastor (2005), Jones and Shanken (2005), and Brown and Wu
(2016). We not only provide evidence that investors learn, but also ask whether they are
responsive enough to signals, as is typically assumed in theoretical models such as Berk and
Green (2004).

We derive our test from the equilibrium in Section I.A. Equation (6) states that, from the
investor’s perspective, all funds should earn zero expected excess net returns. The intuition
behind the mechanism is described as follows. Investors chase performance in the other fund
because they want to allocate more money to skillful managers, and diseconomies of scale
cause inflows to drive down performance. Investors competitively supply funds so that their
expected excess net returns going forward are zero. Therefore, in a frictionless and rational
equilibrium, one would see zero cross-fund return predictability.23 We consider our test a joint
hypothesis test: the joint null is that inflows (outflows) deteriorate (improve) performance
and that investors allocate their capital in accordance with our frictionless benchmark. A
number of studies find evidence of diseconomies of scale in mutual funds (e.g., Chen et al.
(2004), Pollet and Wilson (2008), Yan (2008), Golez and Shive (2015)).24

Under the assumption that size erodes performance, if investors move too little capital
out of Fund 1 in response to poor past performance in Fund 2, Fund 1 will then be larger
than what it should be and will perform poorly. That is, poor past performance in Fund 2
would predict subsequent poor performance in Fund 1. This mechanism also applies to cases
in which investors move too little capital into Fund 1 when Fund 2 has performed well (and
thus Fund 1 will be smaller than what it should be): good past performance in Fund 2 would
predict future good performance in Fund 1. If, however, investors move too much capital
in response to signals from the other fund, past performance in one fund would negatively
predict future performance in the other fund. If the allocation is “correct,” then we should
not observe any cross-fund predictability in fund performance.

Note that mutual fund returns generally show some persistence when performance is

26
poor, as documented by Carhart (1997). Lou (2012) finds that this phenomenon is driven
at least in part by the predictable price pressure arising from flows. When facing outflows,
losing funds liquidate their existing holdings, which are concentrated in past losing stocks.
The future return of these losing stocks is further driven down by the price pressure, and as a
result the funds tend to perform poorly in the next period. Therefore, testing predictability
in a single-fund setting may not directly measure investors’ response to managers’ past
performance. In contrast, using two funds from the same manager allows us to directly
control for past returns and allay concerns about price pressure in the own fund. We are
also able to measure the degree of holdings overlap between funds. Price pressure should be
less of a problem when the two funds have lower overlap.

A. Portfolio Sorts

To test our hypothesis, we first use a single sort: we form portfolios using managers’ Fund
2.25 We sort all Fund 2s into quintiles based on the past 12-month alpha of managers’ Fund
1. In each quintile, we form portfolios that are rebalanced monthly and held for different
time horizons t: 1 month, 3 months, 6 months, and 12 months. Therefore, each month we
rebalance 1/t of each portfolio. For every quintile, the portfolio returns are the cumulative
after-fee returns of Fund 2s in the corresponding quintile. The portfolio alphas are calculated
by regressing the portfolio returns on Carhart (1997) four factors using the full sample period.
The reported t-statistics are based on Newey-West (1987) standard errors with three lags. Insert
Table
Table VII reports the portfolio alphas. Panel A sorts Fund 2s on the after-fee Alpha of
VII
Fund 1, and Panel B sorts on the before-fee Alpha of Fund 1. The two panels reveal similar
patterns: we see increasing portfolio alphas as we move from quintile 1 (lowest Alpha) to
5 (highest), with quintile 1 showing negative alphas and quintile 5 showing weakly positive
alphas. The results hold for different holding periods. The long-short portfolio (5 minus 1)
earns an alpha of around 18 to 47 bps per month.26

27
 Although we find that performance in one of the manager’s funds predicts future returns
in the other fund, this could just be a reflection of the previously documented own-fund
persistence (which could be due to either incomplete learning or flow-driven price pressure)
and the contemporaneous correlation between the two funds’ returns. We therefore examine
the other fund’s incremental predictive power through double sorts. Specifically, we first
sort all Fund 2s into terciles based on the fund’s own past performance. Then within each
tercile, we sort funds into quintiles based on past performance in the manager’s Fund 1.
The returns of the five other-fund-performance quintile portfolios are then averaged across
different terciles of own-fund performance. That is, if r(i, j) is the return of the portfolio of
funds in the ith tercile of own-fund performance and j th quintile of performance in the other
fund, then we compute, for j = 1, . . . , 5:27

r(1, j) + r(2, j) + r(3, j)

r(j) = .
3

Therefore, the final long-short return that we compute is

[r(1, 5) − r(1, 1)] + [r(2, 5) − r(2, 1)] + [r(3, 5) − r(3, 1)]

r = r(5) − r(1) = .
3

If future returns are entirely predicted by past own-fund performance, then r(i, 5) = r(i, 1)
for all i and r = 0. The magnitude of persistence in cross-fund returns obtained from this
test therefore captures the predictability from past performance in the manager’s other fund
above and beyond own-fund persistence. Compared to the single sorts in Table VII, the 5
minus 1 quintile portfolio returns shown in Table VIII, Panel A are a bit smaller, but still
statistically significant in most horizons; the returns also come mostly from lower quintiles
(when the other fund has poor performance).28 (Table IA.VII in the Internet Appendix
shows the full double-sort results without averaging across terciles.) Insert
Table
VIII

28
B. Additional Tests

A few robustness tests are conducted in Tables VIII and IX. First, one may worry about
omitted factors driving the results. If a manager persistently takes on risk not captured by
the Carhart (1997) four-factor model in both of his funds, and if this risk is compensated,
then the manager’s excess returns in both funds will always be positive and correlated, and
the four-factor alphas we report will be positive. Since our results display an asymmetry on
good and poor performance, an omitted risk factor is unlikely to be playing an important
role. Nevertheless, we perform further checks. Table VIII, Panels B and C repeat the double
sort in Panel A using a five-factor model and a seven-factor model, respectively.29 Panel D

uses style-adjusted returns in sorting, and the Carhart (1997) four-factor model in calculating
portfolio alphas. Panel E reverses the order, that is, it uses the Carhart (1997) four-factor
alphas in sorting the funds and reports the future portfolio style-adjusted returns. Style-
adjusted returns are calculated by the fund return minus the average return on all funds
in the same CRSP investment objective code. Thus, we address an important concern that
using the same risk adjustment procedure for sorting funds and calculating (post-sorting)
portfolio performance makes results sensitive to model misspecification. We find that even
when we use different factor models and calculating methods, our results hold.

Second, as discussed before, own-fund predictability is due at least in part to price pres-
sure and tends to reverse in the longer term. We extend the holding horizons to up to 24
months, skipping the most recent six months, in Table IX, Panel A. The double sort does
not show any reversal, and therefore the predictability established earlier is unlikely to be
due to price pressure. Third, we make use of the two placebo samples in Section III.C (the
first set uses the two funds in a period when they are managed by different managers, and
the second set uses a matching fund). The placebo samples in Table IX, Panels B and C do
not show a pattern in predictability like that in Table VIII. This evidence further suggests
that the cross-fund predictability result is not coming from fund-specific omitted risk factors

29
or other trends impacting similar funds. Insert
Table
We also verify the return predictability in a regression framework. We regress the one-
IX
month-ahead style-adjusted return on the rank of the past alpha of the other fund, in the
presence of the rank of the past alpha of the fund in question as well as other characteristics:30

StyleAdjustedReturnt+1 = α + β1 AlphaRankt + β2 Alpha2Rankt + β3 ln(Aget )

+ β4 ln(F undSizet ) + β5 Expenset + β6 ObjF lowt + t , (16)

where AlphaRank and Alpha2Rank are the fractional performance ranks from zero (poorest)
to one (best) based on the past alphas of the fund in question and the other fund, respectively,
as defined in Section III.A. The other variables in equation (16) are the same as those in
equation (15). As in equation (15), in one observation we study the risk-adjusted return of
one fund (say, F1) and the alpha of the other fund (say, F2) of the manager, while in the
other observation F2 becomes the fund in question and F1 becomes the “other fund.” We
use standard Fama-MacBeth (1973) regressions following common practice in cross-sectional
return predictability tests. Newey-West (1987) standard errors using six lags are reported. Insert
Table X
Column (1) of Table X shows that the ranks of the past alphas of both funds can predict
next-month returns. We note that the coefficient on Alpha2Rank is smaller than that on
AlphaRank. Increasing Alpha2 from the 10th to 90th percentile corresponds to a change of 24
bps per month in the next-month return. This effect is similar in magnitude to the double-
sort results in Table VIII. Column (2) is motivated by the results in Tables VII and VIII.
We introduce two dummy variables, LowRank and Low2Rank, to indicate that the fund
in question and the manager’s other fund, respectively, are in the bottom two quintiles of
performance. The coefficient on Low2Rank is negative and significant, while the regression
intercept is statistically insignificant. The results mirror our portfolio sorts: a fund is likely
to continue to perform poorly if the other fund has performed poorly in the past, while the
future performance of the reference group (the higher three quintiles) is close to zero. Column

30
(3) further examines the price pressure question. We add another interactive term to indicate
cases in which the two funds’ weight on common holdings is lower than the sample median
(when U ncommon = 1); because of the lower portfolio overlap, price pressure from the other
fund’s holdings should be weaker. Column (3) shows that the cross-fund predictability result
is not driven by cases in which the funds have more common holdings.

Finally, we reassess the omitted factor explanation. Column (4) presents another ap-
proach to explore such a possibility. In particular, we create a dummy variable, Highcorr,
that equals one if the manager’s four-factor risk-adjusted past returns in the two funds show
a correlation higher than the sample median. If managers have always been loading on
the same omitted factors in both funds, past fund returns will be highly correlated even
after adjusting for Carhart (1997) factors. However, column (4) finds that the coefficient on
Alpha2Rank is not particularly stronger when Highcorr = 1, again indicating that omitted
factors do not play an important role.

Overall, we find that past performance in one fund predicts future performance in the
other fund — particularly when past performance in a given fund is poor. The evidence is
inconsistent with the hypothesis that the response to Alpha2 is sufficient. Our interpretation
is that investors do not withdraw enough capital after poor performance. This finding is in
line with our earlier evidence on cross-fund performance-chasing behavior, that is, investors
are responsive to signals from the other fund when its performance is high.

C. Frictions in Cross-Fund Capital Allocation

In Section I.C we present an extension of the baseline model to a setting with frictions,
under which investors put too much weight on prior beliefs relative to the baseline frictionless
benchmark. The extension allows for three types of frictions: institutional, informational,
and behavioral — loads make it more costly for investors to move capital across funds,
information on fund performance may not be accessible to investors at zero cost, and investors

31
may suffer from conservatism (Edwards (1968), Barberis, Shleifer, and Vishny (1998)) and
as a result overweight priors and underweight new information. In this section, we explore
the role of the different types of frictions affecting cross-fund learning.

In Appendix B we show that higher frictions correspond to stronger cross-fund pre-

dictability and a weaker cross-fund flow-performance relationship. Intuitively, high frictions
drive investor allocations further away from the rational and frictionless equilibrium in Sec-
tion I.A. To examine institutional and informational frictions, we use two proxies based on
fund loads and fund visibility. Loads represent a type of transactions costs charged by in-
stitutions (fund families). We thus create a dummy variable, Loads, that is set to one if
the fund in question charges front-end or back-end loads, and zero otherwise. It is more
expensive for investors to move capital into and out of load funds, potentially limiting in-
vestors’ adjustments. Second, higher fund visibility reduces investors’ costs of information
acquisition. If the other fund’s performance is more visible, then investors’ costs of acquir-
ing information on it should be lower. Following Sirri and Tufano (1998), Barber, Odean,
and Zheng (2005), and Huang, Wei, and Yan (2007), we use 12b-1 fees as a proxy for the
marketing expenses of a fund and create a dummy variable, High12b1, that is set to one if
the 12b-1 fees of the manager’s other fund are in the top tercile of the sample. We interact
the two dummy variables with Alpha2Rank and run regression (16) again, to examine the
effects of these frictions proxies on cross-fund predictability. Insert
Table
In Table XI, Column (1) shows that the coefficient on Alpha2Rank×Loads is positive but
XI
insignificant, while that on Alpha2Rank is positive and significant. While load funds seem
to have stronger cross-fund predictability, it is not significantly different from the no-load
sample. In other words, there is cross-fund predictability in both load and no-load funds,
suggesting that loads are not the only mechanism limiting investors’ response to the other
fund’s signal. In Column (2), we observe that the coefficient on Alpha2Rank × High12b1
is negative and significant, consistent with our prediction that higher fund visibility in the
manager’s other fund reduces information frictions, leading to weaker cross-fund predictabil-

32
ity.

We also introduce interaction terms involving these dummy variables and Alpha2 in
the flow-performance regressions (equation (15), Table III). The signs should be opposite
to those in Table XI: high frictions (captured by Loads = 1 and High12b1 = 0) should
correspond to a weaker cross-fund flow-performance relationship. Our predictions from the
incomplete learning model in Appendix B are supported by the results in Table XII: the
coefficient on Alpha2 × Loads is negative and significant (Column (1)), while the coefficient
on Alpha2 × High12b1 is positive and significant (Column (2)). Insert
Table
To summarize, the results suggest that institutional frictions such as loads, which are
XII
perhaps important, are not the only drivers of cross-fund predictability; on the other hand,
information frictions play a role. We do not rule out behavioral frictions because they may
co-exist with other types of frictions. Our earlier results show that the cross-fund pre-
dictability relationship is stronger when the manager’s other fund performs poorly. While it
is reasonable to think that the equilibrium may take some time to restore, it is not imme-
diately obvious why diseconomies to scale should necessarily take longer to set in following
bad performance, as compared to good performance. On the other hand, our explanations
regarding information and behavioral frictions are perhaps more capable of handling this
asymmetry. If funds or families increase the visibility of well-performing funds, then some
investors would not be able to obtain new information on underperforming funds on a contin-
uous basis, making them rely more on their prior beliefs when the other fund underperforms.
Behavioral frictions such as conservatism can be asymmetric if investors selectively react to
good signals from the other fund to justify their investment decisions, that is, they have
confirmation bias, a tendency to favor confirming information either through biased search
or biased interpretation (Lord, Ross, and Lepper (1979), Nickerson (1998)).

33
 V. Conclusion

We develop and test a model of capital allocations in funds managed by two-fund man-
agers. Our paper contributes to the debate on whether mutual fund investors are rational.
The findings generally support the notion that investors rationally infer managerial ability
from the past returns of both funds. More specifically, flows into a fund are predicted by past
performance in the manager’s other fund. However, capital allocations do not always seem
to be fully consistent with our fully rational and frictionless world. Under the null hypothesis
that size erodes performance, if investors assess the manager’s performance in both funds
correctly, they should allocate capital so that all funds earn zero expected excess returns in
the future. The result would be no predictability in performance. However, we find evidence
of positive cross-fund return predictability. In particular, investors do not seem to withdraw
enough capital in response to poor performance in the manager’s other fund and thus incur
losses. We conclude that although the response in flows is in the right direction, it is not
always sufficient. This conclusion is different from prior literature on investor learning about
mutual funds. Our findings have implications for why some mutual fund investors continue
to invest in poorly performing funds (Gruber (1996), French (2008)): frictions in learning
about managerial skill may be one mechanism driving this phenomenon.

We offer some ideas for future research. Our results on predictability are consistent with
the cross-fund flow-performance relationship, that is, flows show a stronger response to the
other fund when it performs well. To formalize this idea, we extend the model based on
investors’ overweighting on priors. We discuss two possible channels that may explain our
overall findings: costly information acquisition, which means that information on the other
assets managed by the manager is not continuously accessible to investors at zero cost, and
conservatism (Edwards (1968), Barberis, Shleifer, and Vishny (1998), Choi and Hui (2014)),
which causes investors to place more weight on priors and less on new information. Under
the first channel, asymmetry in predictability (stronger when performance is poor) can arise

34
as fund managers or companies are likely to strategically create spillover effects by making
high-performing funds more visible. We find evidence consistent with this story. As for the
second channel, investors may exhibit asymmetry in conservatism due to confirmation bias,
that is, investors may be justifying their investment decisions by selectively reacting only to
good signals from their chosen managers. By studying a setting in which price pressure is not
the main driver of predictability, we hope to shed some light and to provide a framework for
exploring potential explanations. Our extension addresses one of these explanations. There
are certainly other ways to extend the model, but any coherent theory of investor learning
should explain the asymmetry in both cross-fund flow-performance and predictability that
we document.

35
 Appendix A. Derivations and Proofs

(i) We first show the derivation of equation (10). From equation (9),

[P0 + T S]μT = [P0 μ0 + T SRT ]

= [P0 μ0 + S((T − 1)RT −1 + RT )]

= [P0 μ0 + S(T − 1)RT −1 ] + SRT

= [P0 + (T − 1)S]μT −1 + SRT

= [P0 + T S]μT −1 + S[RT − μT −1 ]

⎡ ⎤
⎢c(q1,T −1 )⎥
= [P0 + T S]μT −1 + S[RT − ⎣ ⎦] , from equation (8)
c(q2,T −1 )

= [P0 + T S]μT −1 + SrT , from equation (3).

That is, μT = μT −1 + [P0 + T S]−1 SrT . (10)

(ii) Equation (12) is derived as follows. The precision matrices, S ≡ Ω−1 and P0 ≡ Σ0 −1 ,
are equal to

⎡ ⎤−1 ⎡ ⎤
1
⎢V1 0 ⎥ 0⎥
⎢ V1
S ≡ Ω−1 = ⎣ ⎦ =⎣ ⎦,
1
0 V2 0 V2
⎡ ⎤−1 ⎡ ⎤
⎢ W1 W12 ⎥ 1 ⎢ W2 −W12 ⎥
P0 ≡ Σ−1
0 = ⎣ ⎦ = ⎣ ⎦,
W12 W2 d −W12 W1

2
where d = W1 W2 − W12 .

36
 From equation (11),

⎡ ⎤
⎢c(q1T ) − c(q1,T −1 )⎥ −1
⎣ ⎦ = μT − μT −1 = [P0 + T S] SrT
c(q2T ) − c(q2,T −1 )
⎡ ⎤−1 ⎡ ⎤
W2
⎢ d + V1
T
− d ⎥ ⎢ rV1T1 ⎥
W12
=⎣ ⎦ ⎣ ⎦
− Wd12 W1
d
+ T
V2
r2T
V2
⎡ ⎤−1 ⎡ ⎤
1 −1 ⎢W2 + V1
Td
−W12 ⎥ ⎢ rV1T1 ⎥
=( ) ⎣ ⎦ ⎣ ⎦
d −W12 W1 + TV2d r2T
V2
⎡ ⎤⎡ ⎤
d ⎢ W1 + V2
Td
W12 ⎥ ⎢ rV1T1 ⎥
= ⎣ ⎦⎣ ⎦, (A1)
Δ W12 Td
W2 + V1 r2T
V2

Td Td 2
where Δ = (W1 + )(W2 + ) − W12
V2 V1
2 T 2 d2 W1 W 2
= W1 W2 − W12 + + T d( + )
V1 V2 V1 V2
T 2 d2 W1 W2
=d+ + T d( + ) > 0.
V1 V2 V1 V2

For Fund 1,
c(q1T ) − c(q1,T −1 ) = A1 r1T + A2 r2T , (12)

Td
d W1 + V2
where A1 = ,
Δ V1
d W12
A2 = .
Δ V2

(iii) Proof of Proposition 1: Since d and Δ are determinants of matrices, they must be
positive. All the other terms in A1 are positive by definition. The coefficient A2 is
positive as long as the covariance of the beliefs, W12 , is positive.

37
(iv) Proof of Proposition 2: Again for Fund 1,

Td Td
d W1 + V2
W1 + V2
A1 = = T 2d
Δ V1 V1 [1 + V1 V2
+ T (W 1
V1
+ W2
V2
)]
d W12 W12
A2 = = T 2d
, (A2)
Δ V2 V2 [1 + V1 V2
+ T (W
V1
1
+ W2
V2
)]

2
where d = W1 W2 − W12 . As W12 increases, d decreases; the numerator of A2 increases
and the denominator decreases. If W12 is more positive, A2 should be higher (more
positive).

The relationship between A1 and W12 is given by

∂A1 ∂A1
Sign( ) = Sign(V1 )
∂d ∂d
2 Td T2
[1 + VT1 Vd2 + T ( W
V1
1
+WV2
2
)] VT2 − (W1 + )
V2 V1 V2
= Sign( 2 )
[1 + VT1 Vd2 + T ( WV1
1
+W 2
V2
)]2
[1 + T W 2 T
]
V2 V2
= Sign( T 2d W2 2
) > 0.
[1 + V1 V2
+ T (W
V1
1
+ V2
)]

2
Again, d = W1 W2 − W12 . Therefore, A1 increases with d and decreases with W12 .

(v) Proof of Proposition 3: From equation (A2), A2 increases with V1 (the variance of R1t )
as the denominator decreases; A1 decreases with V1 as the denominator increases.

Also from equation (A2), A2 decreases with V2 (the variance of R2t ) as the denominator
increases.

38
 The relationship between A1 and V2 is given by

∂A1 ∂A1
Sign( ) = Sign(V1 )
∂V2 ∂V2
T 2d W1 W2 T d T d 1 T 2d
= Sign(−[1 + + T( + )] 2 + (W1 + ) ( + T W2 ))
V1 V2 V1 V2 V2 V2 V22 V1
T d T 3 d2 T 2 dW1 T 2 dW2 T 2 dW1 T W1 W2 T 3 d2 T 2 dW2
= Sign(− 2 − − − + + + + )
V2 V1 V23 V1 V22 V23 V1 V22 V22 V1 V23 V23
T d T W1 W2
= Sign(− 2 + )
V2 V22
T
= Sign( 2 (W1 W2 − d))
V2
2
= Sign(W1 W2 − W1 W2 + W12 ) > 0.

(vi) Proof of Proposition 4: From equation (A2), A2 decreases with T as the denominator
increases. The relationship between A1 and T is given by

∂A1 ∂A1
Sign( ) = Sign(V1 )
∂T ∂T
T 2d W1 W2 d T d 2T d W1 W2
= Sign([1 + + T( + )] − (W1 + )( + + ))
V1 V2 V1 V2 V2 V2 V1 V2 V1 V2
d T 2 d2 T dW1 T dW2 2T dW1 W12 W1 W2 2T 2 d2 T dW1 T dW2
= Sign( + + + − − − − − − )
V2 V1 V22 V1 V2 V22 V1 V2 V1 V2 V1 V22 V1 V2 V22
d T 2 d2 2T dW1 W12 W1 W2
= Sign( − − − − )
V2 V1 V22 V1 V2 V1 V2
T 2 d2 2T dW1 W12 W1 W2 − d
= Sign(− − − − )
V1 V22 V1 V2 V1 V2
T 2 d2 2T dW1 W12 W12 2
= Sign(− − − − ) < 0.
V1 V22 V1 V2 V1 V2

Appendix B. Extension: Learning with Frictions

In this extension, the investor’s expectation operator, E I [.], is different from the fully
rational and frictionless (“true”) expectation operator, E[.]. The former is the expectation
operator under investors’ beliefs and information sets. We discuss three possible channels

39
for investor learning to be not fully rational and frictionless. First, transactions costs such
as front-end and back-end loads make it more costly for investors to allocate their capital
according to the signals. The second channel corresponds to investors operating under an
incomplete (not completely updated) information set and having to use the last available
information, which might differ from current information. The third channel pertains to
investors believing (incorrectly) that the optimal update rule involves putting a weight on
their prior that turns out to be “too high” under Bayesian rules.

From investors’ point of view, they still try to competitively allocate capital to funds so
that all funds earn zero expected excess net returns, under their expectations. Therefore,

ETI [ri,T +1 ] = 0,
⎡ ⎤
⎢R1,T +1 − c(q1T )⎥ C(qit )
that is, ETI [⎣ ⎦] = 0, where c(qit ) ≡ +f
R2,T +1 − c(q2T ) qit
⎡ ⎤
⎢c(q1T )⎥
ETI [RT +1 ] = ⎣ ⎦. (B1)
c(q2T )

Denote the expected gross returns under investors’ beliefs and information at time T as μIT .
We then have ⎡ ⎤
⎢c(q1T )⎥
μIT ≡ ETI [RT +1 ] = ⎣ ⎦. (B2)
c(q2T )

These equations correspond to equations (6) to (8) in Section I.A. Recall that under the
fully rational and frictionless model in Section I, from equation (13) we have

μT = {I − M }μT −1 + M RT , (B3)

where M = [P0 + T S]−1 S. To reflect overweighting on priors and underweighting on new

40
information, we modify equation (B3) as follows:

μIT = {I − kM }μIT −1 + kM RT

= μIT −1 + kM [RT − μIT −1 ], (B4)

where 0 < k < 1.31 Applying equation (B2),

⎡ ⎤
⎢c(q1,T −1 )⎥
μIT = μIT −1 + kM [RT − ⎣ ⎦]
c(q2,T −1 )

= μIT −1 + kM rT , from equation (3). (B5)

This corresponds to equation (10) in Section I.A, which specifies how investors update the

posterior means of their beliefs on ψψ12 . We are again interested in investors’ flows into and
out of Funds 1 and 2. As in Section I.A, we examine the change in the unit cost. From
equations (B2) and (B5),

⎡ ⎤
⎢c(q1T ) − c(q1,T −1 )⎥
⎣ ⎦ = kM rT
c(q2T ) − c(q2,T −1 )
⎡ ⎤⎡ ⎤
Td
d ⎢ W1 + V2 W12 ⎥ ⎢ rV1T1 ⎥
=k ⎣ ⎦ ⎣ ⎦ , from equation (A1). (B6)
Δ W12 Td
W2 + V 1 r2T
V2

For Fund 1,
d T d r1T r2T
c(q1T ) − c(q1,T −1 ) = k [(W1 + ) + W12 ]. (B7)
Δ V2 V1 V2

To simplify the exposition that follows, several additional assumptions and notation are
used. First, we assume that the size of the funds, q, at time T − 1 is the same across the
two models, namely, the fully rational and frictionless model in Section I.A and the model
extension with frictions here. Second, we denote the size of the fund at time T as q R and q I
for the models in Section I.A and here, respectively.

41
 As we argue in Section I.A, flows into Fund 1 are monotonically increasing in the change
in the unit cost. Denote the change in the unit cost under the rational and frictionless
R
equilibrium as F1T . From equation (12), flows into Fund 1 at time T under the rational and
frictionless equilibrium are increasing in

d T d r1T r2T
R
F1T ≡ c(q1T
R
) − c(q1,T −1 ) = [(W1 + ) + W12 ]
Δ V2 V1 V2
= A1 r1T + A2 r2T . (B8)

I
Denote the change in the unit cost under the equilibrium with frictions as F1T . From equation
(B7), flows into Fund 1 at time T under the equilibrium with frictions are increasing in

d T d r1T r2T
I
F1T ≡ c(q1T
I
) − c(q1,T −1 ) = k [(W1 + ) + W12 ]
Δ V2 V1 V2
= kA1 r1T + kA2 r2T . (B8’)

Recall that 0 < k < 1 captures the degree of overweighting on the prior and underweighting
on new information (a smaller k indicates a larger deviation from the rational and frictionless
benchmark). Therefore, the responses in flows to the own fund and to the other fund are
increasingly insufficient as k declines. Note, however, that the cross-sectional predictions
from our baseline model (Propositions 2 to 4) still hold, even under the updating rule in
equation (B4).

We now consider the return on Fund 1. From equation (3), r1,T +1 = R1,T +1 − c(q1T ) =
R1,T +1 − cq1,T − f . The “true” expected future excess net return under fully rational and
frictionless conditions is

E[r1,T +1 ] = E[R1,T +1 ] − c(q1T

R
) − f = 0. (B9)

On the other hand, the true expected future excess net return under investors’ updating rule

42
in equation (B4) is

E[r1,T +1 ] = E[R1,T +1 ] − c(q1T

I
)−f

= E[R1,T +1 ] − c(q1T
R
) − f + c(q1T
R
) − c(q1T
I
)
R
= c(q1T ) − c(q1T
I
)
R
= F1T + c(q1,T −1 ) − F1T
I
− c(q1,T −1 )

= (1 − k)A1 r1T + (1 − k)A2 r2T . (B10)

As 0 < k < 1, we observe positive own-fund and positive cross-fund predictability.

Although we do not model the underlying investor behavior and the incomplete informa-
tion environment, related papers indicate that equation (B4) is a reasonable approximation.
The parameter k parsimoniously captures the behavioral bias that investors place too much
weight on priors, and Brav and Heaton (2002) show that this is analogous to a case in which
rational investors do not have complete information of the fundamentals.

Appendix C. Procedures for Constructing a Placebo

Sample

Let F1 be the fund in quesion and F2 be the manager’s other fund. We find a control fund,
M2, that matches F2 based on family information and fund characteristics. In particular,
when each multi-fund manager starts managing two funds, we find a match from the universe
of single-manager funds as follows:

(i) We pick funds (in the same month) that come from the same family and whose assets
are 25% to 200% of the multi-fund manager’s fund F2.

(ii) In the event that there is no eligible fund in (i) (family information is missing, or there

43
 are no family funds with 25% to 200% of assets), we pick funds (in the same month)
whose assets are 90% to 110% of the multi-fund manager’s fund F2.32

(iii) From all eligible funds we calculate

Eligible Fund’s Standard Deviation

Score = abs( − 1)
Standard Deviation
Eligible Fund’s Fund Age
+ abs( − 1)
Fund Age
Eligible Fund’s Expense
+ abs( − 1).
Expense

We pick the fund with the lowest Score to be M2. The same M2 is used throughout the
manager’s tenure in the two funds.

44
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52
 Notes

1
Elton, Gruber, and Busse (2004) and Choi, Laibson, and Madrian (2010) find that some mutual fund
investors are unable to make the right choice in the simplest possible context, and hence question whether
investors have the required level of sophistication.

2
Skill seems to be related to managerial characteristics such as education (Chevalier and Ellison (1999a)),
past experience (Pool, Stoffman, and Yonker (2012), Kempf, Manconi, and Spalt (2014)), and social networks
(Cohen, Frazzini, and Malloy (2008), Pool, Stoffman, and Yonker (2015)). Using novel measures of ability,
several papers find that some fund managers are better than others (e.g., Kacperczyk and Seru (2007),
Kacperczyk, Sialm, and Zheng (2008), Cremers and Petajisto (2009), Baker et al. (2010)).

3
As argued by Berk and Green (2004), Chen et al. (2004), and Yan (2008), fund size may erode per-
formance because managers of larger funds spread their information-gathering activities too thin, and large
trades have higher price impact and execution costs.

4
Carhart (1997) documents some persistence in performance, especially among underperforming funds,
but the driving forces are not well understood. To explain the continued investment in poor performers,
some authors focus on the role of biases in investor information sets or search frictions (e.g., Gruber (1996),
Goetzmann and Peles (1997)), while an alternative view relates persistence in poor performance to flow-
driven price pressure (e.g., Lou (2012)). Prior research does not provide conclusive evidence.

5
Information on managers, including other funds they manage, is easily accessible to investors via in-
vestment resources such as Morningstar. See, for example, http://financials.morningstar.com/fund/
management.html?t=JARTX&region=USA&culture=en-US. Also, some fund managers get a considerable
amount of media coverage, especially following good performance (Chevalier and Ellison (1999b), Ding and
Wermers (2012)).

6
We model ψi s as partly fund-specific and partly manager-specific for parsimony. The model is robust
to an alternative specification in which fund-specific excess returns and manager-specific excess returns are
separate parameters.

7
Our definition of skill is different from, for example, Berk and van Binsbergen (2014), who argue that
manager skill should be assessed by the value that his fund extracts from markets. Their measure of fund
value-added is the gross return over its benchmark multiplied by total assets under management. It is a
dollar-based measure that takes into account the total value extracted from investors through fees, while our

53
focus is on how investors make their capital allocations based on their perceived return.

8
Brown and Wu (2016) allow idiosyncratic shocks to be positively correlated. To keep the model simple,
we abstract from this correlated noise effect.

9
In a more complicated model, fees can be endogenous. We keep our model simple by abstracting from
managerial fee-related issues. Also, although we discuss some possible reasons for the existence of multi-fund
managers in Section II, the model is silent on how managers are assigned to funds. The current setting refers
to situations in which investors start learning about the manager after he begins to manage two funds.

10
For a formal proof that c (q) > 0, see Berk and Green (2004, p.1276). The interested reader can also see
Berk and Green (2004) for a cost function that expresses the equation in terms of percentage flow.

11
In both the model and the empirical tests, we examine the flow-performance relationship at the fund
level. We only require that investors of Fund 1 take into account Fund 2’s past performance when they
decide how much to invest in Fund 1; it is not necessary that every investor of Fund 1 also invest in Fund 2.
Furthermore, an investor of Fund 1 can buy Fund 1 at any time, that is, he does not have to wait for Fund
2 to be created or assigned to the manager. In other words, Funds 1 and 2 may have different clienteles.
However, our fund-level data do not allow us to examine these different clienteles more closely.

12
The model can also accommodate underweighting of priors and overweighting of new information if we
allow k > 1. The remainder of the analysis will be analogous, so we focus on k < 1 for clarity and simplicity.
Ultimately, whether our data are more consistent with 0 < k < 1 or k > 1 is empirically testable, as we show
in Section IV.

13
We link CRSP and Thomson-Reuters data using the Mutual Fund Links database. We thank Russ
Wermers for making this database available. For more detailed information, please see Wermers (2000).

14
There are a number of data sources to identify managers: CRSP (e.g., Kacperczyk and Seru (2007)),
Morningstar (e.g., Pool, Stoffman, and Yonker (2012)), and other sources such as Nelson’s Directory of Invest-
ment Managers, Zoominfo, and Zabasearch (e.g., Kacperczyk, van Nieuwerburgh, and Veldkamp (2014)).
Recent papers highlight the challenges of identifying the management structure (e.g., team-managed or
anonymously managed) using CRSP or Morningstar. According to Massa, Reuter, and Zitzewitz (2010), the
main problems arise from (i) CRSP sometimes not reporting any manager name when a fund has more than
three managers, and (ii) Morningstar classifying any fund with more than two managers as “Team Managed”
(prior to 1997), without reporting the managers’ names. Another data concern is that some team-managed
funds are misclassified as single-managed funds (Patel and Sarkissian (2014)). As we do not focus on dif-

54
ferent types of management structures, these issues are not critical. Nonetheless, we follow Agarwal, Ma,
and Mullally (2015) and exclude cases in which a manager runs more than four funds, as these managers
are likely to be team managers. Note that some of the concerns pointed out in the past are not applicable
to our data set, since we have hand-cleaned the data using public information available outside of CRSP.
For example, we explicitly account for differences in reporting the manager’s name. Finally, in the Internet
Appendix (Table IA.V) we report that our main results on flow-performance and predictability regressions
are similar, even when we only use fund pairs that have consistent manager information from Morningstar
Direct. The Internet Appendix is available in the online version of this article on the Journal of Finance
website.

15
This does not mean that the two funds of the same manager are always very similar. If we remove all
common holdings between the two funds (say, both funds hold 3% in IBM), the median “uncommon weight”
is about 60%. Many of the stock picks are specific to each fund, which may not be too surprising because the
funds often have different styles (due to, say, institutional restrictions or client preferences), and managers
have incentives to create at least one good-performing fund (Yadav (2010)), so they do not necessarily pick
the same set of stocks in both funds. Section III.B provides an empirical proxy for the difference in styles
between the two funds.

16
We also use an alternative definition of F lowit , which has an additional term (1+Rit ) in the denominator.
Using this definition, flows will not be lower than −100%. The Internet Appendix (Table IA.I) shows that
our results are robust to the alternative measure.

17
In the Internet Appendix (Table IA.III), we use style-adjusted returns instead of alphas as an alternative
specification. The style-adjusted return is calculated as the monthly return on the fund in excess of the
average return on all funds in the same CRSP investment objective code over the prior 12 months. The
regression equation for this alternative specification is the same as equation (15), except that the performance
variables are defined based on style-adjusted returns. Our conclusions remain very similar.

18
Since our sample of multi-fund managers is a subset of all mutual funds, we do not have too many obser-
vations in each month-year and we choose to conduct our main analysis in a panel regression. Nevertheless,
after excluding month-years with fewer than 25 observations, we find that the results using Fama-Macbeth
(1973) regressions are similar to those using panel regressions. The Fama-Macbeth (1973) regressions are
reported in the Internet Appendix (Table IA.II).

19
Manager or family fixed effects are included in some specifications, because recent studies show that
certain family (e.g., Hortacsu and Syverson (2004)) and managerial (e.g., Kumar, Niessen-Ruenzi, and Spalt

55
(2015)) characteristics attract more flows.

20
The coefficients are interpreted as follows. Suppose the coefficients on Low Alpha, M id Alpha, and
High Alpha are β1 , β2 , and β3 , respectively, and that the regression intercept is α. If all other independent
variables are equal to zero, a fund in the 5th percentile would have flows that equal (α + Low Alpha × β1 =
α+0.05β1 ), while a fund in the 95th percentile would have flows that equal (α+Low Alpha×β1 +M id Alpha×
β2 + High Alpha × β3 = α + 0.2β1 + 0.6β2 + 0.15β3 ). The corresponding variables of the other fund
(Low Alpha2, M id Alpha2, and High Alpha2) are interpreted similarly.

21
Instead of using flows into funds in the same objective, a further robustness test is conducted using flows
into funds in the same style, defined based on past Carhart (1997) four-factor loadings. We do this in case
some funds follow investment styles that are different from the objectives stated in their prospectus. The
results, reported in the Internet Appendix (Table IA.IV), are again similar.

22
The dummy variable T imeM anageRank is measured within the fund pair, and is the exact analog of
the model parameter T . Also, as we do not observe managers’ complete track records, managers’ overall
tenure (i.e., how long they have been managing funds in the mutual fund industry) cannot be measured
correctly. In contrast, T imeM anageRank can be measured in our data.

23
This test is similar in spirit to Glode et al. (2012), who use Berk and Green’s (2004) model as a
benchmark and study own-fund predictability in up and down markets. It is possible that investors respond
to fund performance with the right level of capital flows in the single-fund setting — performance appears to
be unpredictable in some cases such as directly sold funds (Del Guercio and Reuter (2014)). However, to the
best of our knowledge, to date no one has looked at predictability with multiple funds. This is surprising,
as we argue later in this section, since the multi-fund setting is particularly suitable for allaying concerns
about price pressure that may obscure the relationship between own-fund predictability and the mechanism
in Berk and Green’s (2004) equilibrium.

24
The joint null exactly mirrors Berk and Green’s (2004) model. A growing literature investigates the
diseconomies of scale in the money management industry. As conjectured by Berk and Green (2004),
managers run out of ideas (e.g., Pollet and Wilson (2008), Cremers and Petajisto (2009)) and incur greater
trading costs (e.g., Edelen, Evans, and Kadlec (2007)) as their asset base grows. Reuter and Zitzewitz (2015)
use exogenous variation in fund size that is triggered by Morningstar star rankings. This strategy, however,
generates economically modest variation in fund size, and Reuter and Zitzewitz (2015) do not find evidence
for diseconomies of scale. Pastor, Stambaugh, and Taylor (2015) discuss omitted variable bias in estimating
the relationship between fund returns and size through OLS. The omitted variables introduce a positive

56
bias in the coefficient estimate, because skill and size are likely to be positively correlated. Diseconomies of
scale (negative coefficient in a regression of fund performance on lagged size) are therefore more difficult to
detect using OLS. Despite this, some previous papers have documented a negative relationship between fund
returns and size. To correct for the bias, Pastor, Stambaugh, and Taylor (2015) propose a method known
as “recursive demeaning,” which requires the availability of a long time series. A long time series is more
readily available at the industry level but not at the fund level. As a result, a recursive demeaning method
may lack statistical power for fund-level tests (the recursive demeaning procedure provides economically
larger estimates of diseconomies of scale than OLS, but the estimates are statistically insignificant). Pastor,
Stambaugh, and Taylor (2015) conclude that “Overall, we find mixed evidence of decreasing returns to scale
at the fund level. The estimates are invariably negative, but our tests do not have enough power to establish
statistical significance” (p.25). They show stronger diseconomies of scale at the industry level.
Finally, there is also some evidence of decreasing returns to scale outside open-end mutual funds. For
example, Fung et al. (2008) and Ramadorai (2013) find such evidence for hedge funds and Wu, Wermers,
and Zechner (2015) for closed-end funds.

25
Even though we do not control for other factors in the single sort, price pressure is still less of a concern
since portfolio overlap between Fund 1 at t and Fund 2 at t + 1 is lower than that between Fund 1 in two
consecutive periods.

26
Notice that this is not a fully implementable trading strategy: a large portion of the profits comes from
the short leg of the portfolios, and mutual funds cannot be short sold.

27
We use terciles of the first sorting variable, own-fund performance, instead of quintiles, in order to retain
a sufficient number of funds within each group (i, j).

28
Once we control for own-fund past performance, the lowest quintile shows weaker statistical significance,
perhaps because of price pressure affecting the overlapping parts of these funds. The second lowest quintile
is generally the most significant. The t-statistics for the third and fourth quintiles also increase but usually
not enough to become significant. Recall that the cross-fund flow-performance relationship comes primarily
from the top quintile, which still has very weak predictability in this table.

29
The five factors are the Carhart (1997) factors plus the Pastor and Stambaugh (2003) liquidity factor.
The seven factors are the five factors plus short-term and long-term reversals, which are obtained from Prof.
Kenneth French’s website.

30
We use the ranks of alphas as they are easier to compare with the results in portfolio sorts. This regression

57
is also similar in spirit to the double sort in Table VIII, Panel E (that is, the dependent variable is the future
style-adjusted return, while the past return variables on the right-hand side use four-factor alphas). In the
Internet Appendix (Table IA.VI), we report a similar regression with one-month-ahead RiskAdjustedReturn
as the dependent variable. This is the future fund return adjusted by the Carhart (1997) four factors. The
regression can be compared with the double sort in Table VIII, Panel A.

31
While we model the biased update in a multiplicative manner (kM ), modeling it in an additive way
(e.g., M − kI) gives the same conclusion.

32
The results are robust to skipping this step and only using same-family funds. The flow-performance
results and the cross-fund predictability results using same-family placebo funds are reported in the Internet
Appendix (Table IA.VIII).

58
 Table I
Summary Statistics: Multi-Funds vs. Single-Funds

This table presents summary statistics of multi-funds (funds managed by people who manage more
than one fund) in Panel A, and of single-funds (funds managed by people who manage only one fund)
in Panel B. ln (Family Size) is the natural logarithm of the fund family’s total net assets under
management. All other variables are defined in Table XIII.

Mean Median Std P25 P75

Panel A: Multi-Fund Managers’ Funds
Flow 0.0052 -0.0028 0.0434 -0.0146 0.0147
Alpha -0.0007 -0.0008 0.0092 -0.0050 0.0032
Stdret 0.0497 0.0455 0.0252 0.0313 0.0615
ln (Age) (years) 2.4642 2.4849 0.8037 1.9459 2.9444
ln (FundSize) ($millions) 5.8156 5.8058 1.5439 4.6747 6.9126
Expense 0.0150 0.0148 0.0056 0.0103 0.0192
ln (FamilySize) ($millions) 9.0620 8.8840 2.7380 7.4450 10.7110
N = 29,899
Panel B: Single-Fund Managers’ Funds
Flow 0.0050 -0.0016 0.0409 -0.0129 0.0145
Alpha -0.0002 -0.0005 0.0089 -0.0043 0.0034
Stdret 0.0467 0.0418 0.0247 0.0288 0.0581
ln (Age) (years) 2.4797 2.4849 0.7985 1.9459 2.9957
ln (FundSize) ($millions) 5.6428 5.4765 1.6603 4.4034 6.7005
Expense 0.0150 0.0144 0.0056 0.0103 0.0192
ln (FamilySize) ($millions) 9.2222 9.3562 2.8916 7.3440 11.2887
N = 60,306

ln (FamilySize): N = 17,396 in Panel A and N = 28,389 in Panel B due to missing data.


 Table II
Summary Statistics: The Two Funds of Multi-Fund Managers

This table presents summary statistics of the two funds of multi-fund managers. We pick two funds
(F1 and F2) from each manager. Panels A and B provide information on fund characteristics for F1
and F2, respectively, and Panels C and D present estimated loadings from the Carhart four-factor
model. All variables are defined in Table XIII.

Mean Median Std P25 P75

Panel A: F1 Characteristics
Alpha -0.0005 -0.0007 0.0089 -0.0047 0.0031
Stdret 0.0506 0.0463 0.0259 0.0318 0.0619
ln (Age) 2.4803 2.4849 0.8146 1.9459 2.9957
ln (FundSize) 5.9919 5.9829 1.4560 4.9228 7.0170
Expense 0.0146 0.0141 0.0053 0.0101 0.0188
Panel B: F2 Characteristics
Alpha -0.0006 -0.0007 0.0090 -0.0048 0.0033
Stdret 0.0492 0.0453 0.0239 0.0319 0.0609
ln (Age) 2.4696 2.4849 0.7812 1.9459 2.8904
ln (FundSize) 5.9234 5.9132 1.5528 4.8291 6.9870
Expense 0.0146 0.0145 0.0056 0.0099 0.0193
Panel C: F1 Loadings
MKT 0.993 0.983 0.322 0.834 1.133
SMB 0.173 0.081 0.460 -0.122 0.414
HML 0.020 0.029 0.556 -0.266 0.307
UMD 0.028 0.010 0.370 -0.138 0.173
Panel D: F2 Loadings
MKT 0.982 0.974 0.320 0.815 1.132
SMB 0.190 0.105 0.456 -0.105 0.454
HML 0.013 0.020 0.545 -0.271 0.323
UMD 0.039 0.017 0.339 -0.128 0.187


 Table III
Flow-Performance Regression in Multi-Funds

This table presents results from flow-performance regressions using OLS. In Columns (1) to (4), the
dependent variable is Flow, which is the proportional monthly growth in total assets under
management; the dependent variable in columns (5) to (8) is Adjusted Flow, which is Flow minus Obj
Flow. Alpha and Alpha2 are the risk-adjusted returns of the fund and the other fund, respectively. In
Columns (3), (4), (7), and (8), we use a piecewise linear specification. For each month, we assign a
fractional Rank from zero (worst) to one (best) to each fund, and define Low Alpha = Min(Rank, 0.2),
Mid Alpha = Min(0.6, Rank – Low Alpha), and High Alpha = Rank – Mid Alpha – Low Alpha. Standard
errors are clustered at the manager level. All other variables are defined in Table XIII. *, **, and ***
denote 10%, 5%, and 1% significance, respectively.


 Flow
(1) (2) (3) (4)

Alpha 0.4100*** 0.7489***

(0.0500) (0.1589)
Alpha2 0.0697* 0.0787**
(0.0365) (0.0362)
Low Alpha 0.0156*** 0.0149**
(0.0058) (0.0066)
Mid Alpha 0.0083*** 0.0092***
(0.0015) (0.0016)
High Alpha 0.0391*** 0.0485***
(0.0096) (0.0115)
Low Alpha2 0.0103 0.0069
(0.0066) (0.0073)
Mid Alpha2 -0.0025 -0.0029
(0.0017) (0.0018)
High Alpha2 0.0190** 0.0220**
(0.0079) (0.0086)
Alpha x Stdret -2.0138**
(0.9422)
Alpha x ln (Age) -0.0897**
(0.0453)
ln (Age) -0.0008** -0.0009** -0.0008** 0.0000
(0.0004) (0.0004) (0.0004) (0.0006)
ln (FundSize) -0.0003* -0.0003* -0.0003* -0.0021***
(0.0002) (0.0002) (0.0002) (0.0004)
Expense 0.0535 0.0552 0.0514 -0.0399
(0.0560) (0.0558) (0.0566) (0.0981)
Stdret -0.0348** -0.0332** -0.0430*** -0.0152
(0.0165) (0.0161) (0.0164) (0.0424)
Obj Flow 0.2937*** 0.2958*** 0.2918*** 0.4180***
(0.0547) (0.0551) (0.0553) (0.0672)
Constant 0.0076 0.0081 -0.0008 0.0133*
(0.0051) (0.0051) (0.0052) (0.0070)

Observations 19,538 19,538 19,538 19,538

R2 0.365 0.365 0.365 0.275
Past Flows Yes Yes Yes Yes
Manager FE No No No Yes
Year-Month FE Yes Yes Yes Yes


 Adjusted Flow
(5) (6) (7) (8)

Alpha 0.4069*** 0.7383***

(0.0497) (0.1581)
Alpha2 0.0654* 0.0742**
(0.0366) (0.0363)
Low Alpha 0.0163*** 0.0154**
(0.0058) (0.0066)
Mid Alpha 0.0082*** 0.0091***
(0.0015) (0.0016)
High Alpha 0.0386*** 0.0481***
(0.0096) (0.0115)
Low Alpha2 0.0102 0.0067
(0.0066) (0.0074)
Mid Alpha2 -0.0024 -0.0028
(0.0017) (0.0019)
High Alpha2 0.0179** 0.0211**
(0.0079) (0.0086)
Alpha x Stdret -1.9474**
(0.9432)
Alpha x ln (Age) -0.0884**
(0.0450)
ln (Age) -0.0008** -0.0009** -0.0008** 0.0000
(0.0004) (0.0004) (0.0004) (0.0006)
ln (FundSize) -0.0003* -0.0003* -0.0003* -0.0021***
(0.0002) (0.0002) (0.0002) (0.0004)
Expense 0.0508 0.0524 0.0492 -0.0421
(0.0555) (0.0553) (0.0561) (0.0981)
Stdret -0.0336** -0.0321** -0.0411** -0.0123
(0.0163) (0.0159) (0.0162) (0.0420)
Obj Flow

Constant 0.0105** 0.0109** 0.0019 0.0163**

(0.0050) (0.0050) (0.0052) (0.0068)

Observations 19,538 19,538 19,538 19,538

R2 0.346 0.346 0.346 0.245
Past Flows Yes Yes Yes Yes
Manager FE No No No Yes
Year-Month FE Yes Yes Yes Yes


 Table IV
Flow-Performance Regression in Multi-Funds: Cross-Sectional Tests

This table presents results from flow-performance regressions, in which we interact alphas with style
difference, return volatility, and the number of periods that the manager has been managing the two
funds. StyleRank and VolRank (Vol2Rank) are dummy variables equal to one when the observation is
above the sample median. TimeManageRank equals one for the latter half of the manager’s tenure in
this fund pair, and zero otherwise. The dependent variable is Flow. Alpha and Alpha2 are the risk-
adjusted returns of the fund and the other fund, respectively. We present results using OLS with errors
clustered at the manager level. All other variables are defined in Table XIII. *, **, and *** denote 10%,
5%, and 1% significance, respectively.


 (1) (2) (3) (4) (5)

Alpha 0.2944*** 0.4580*** 0.5989*** 0.5725*** 0.5236***

(0.0615) (0.1216) (0.0654) (0.0715) (0.0691)
Alpha2 0.1947*** 0.1624 -0.0622 -0.0788 0.0967*
(0.0608) (0.1145) (0.0637) (0.0776) (0.0586)
Alpha x StyleRank 0.1640** 0.1553*
(0.0809) (0.0806)
Alpha2 x StyleRank -0.1864*** -0.1833***
(0.0700) (0.0686)
Alpha x VolRank -0.2642*** -0.2573***
(0.0877) (0.0896)
Alpha2 x VolRank 0.2034** 0.1927**
(0.0798) (0.0908)
Alpha x TimeManageRank -0.1815**
(0.0779)
Alpha2 x TimeManageRank -0.0370*
(0.0204)
StyleRank -0.0001 -0.0001
(0.0005) (0.0005)
VolRank 0.0003 -0.0001
(0.0008) (0.0008)
TimeManageRank -0.0011*
(0.0006)
Alpha x Vol2Rank 0.0226
(0.0835)
Alpha2 x Vol2Rank 0.0240
(0.0946)
Vol2Rank 0.0007
(0.0006)
Alpha x OneVolatileFund -0.1974*
(0.1177)
Alpha2 x OneVolatileFund 0.0334
(0.1118)
OneVolatileFund -0.0002
(0.0007)
ln (Age) -0.0008** -0.0009** -0.0009** -0.0008** -0.0009**
(0.0004) (0.0004) (0.0004) (0.0004) (0.0004)
ln (FundSize) -0.0003* -0.0003 -0.0003* -0.0003* -0.0003
(0.0002) (0.0002) (0.0002) (0.0002) (0.0002)
Expense 0.0528 0.0560 0.0532 0.0438 0.0622
(0.0559) (0.0559) (0.0560) (0.0584) (0.0567)
Stdret -0.0358** -0.0322 -0.0392* -0.0381 -0.0343**
(0.0165) (0.0202) (0.0233) (0.0246) (0.0169)
Obj Flow 0.2948*** 0.3004*** 0.2977*** 0.2815*** 0.2929***
(0.0546) (0.0551) (0.0543) (0.0556) (0.0550)
Constant 0.0077 0.0075 0.0071 0.0095* 0.0077
(0.0051) (0.0051) (0.0051) (0.0054) (0.0061)

Observations 19,530 19,530 19,538 18,371 19,538


 R2 0.365 0.365 0.365 0.365 0.372
Past Flows Yes Yes Yes Yes Yes
Year-Month FE Yes Yes Yes Yes Yes


 Table V
Flow-Performance Regression in Multi-Funds: Controlling for Family Effects

This table presents results from flow-performance regressions, in which we control for family effects.
Columns (1) and (2) control for Family Alpha. In Column (1), Family Alpha is the average alpha of the
family excluding the fund; in Column (2) the average excludes the two funds from the manager.
Column (3) adds Star Manager, and Column (4) completes the analysis by including Family Fixed Effects
(FE). The dependent variable is Flow. Alpha and Alpha2 are the risk-adjusted returns of the fund and
the other fund, respectively. We present results using OLS with errors clustered at the manager level.
All other variables are defined in Table XIII. *, **, and *** denote 10%, 5%, and 1% significance,
respectively.

(1) (2) (3) (4)

Alpha 0.4368*** 0.3863*** 0.3796*** 0.3786***

(0.0374) (0.0461) (0.0462) (0.0479)
Alpha2 0.0878** 0.0828* 0.0791*
(0.0445) (0.0445) (0.0472)
ln (Age) -0.0008 -0.0008 -0.0007 -0.0003
(0.0005) (0.0005) (0.0005) (0.0007)
ln (FundSize) -0.0002 -0.0001 -0.0002 -0.0012***
(0.0002) (0.0002) (0.0002) (0.0003)
Expense 0.1307** 0.1127* 0.1142* -0.1089
(0.0582) (0.0589) (0.0589) (0.1003)
Stdret -0.0227 -0.0198 -0.0198 -0.0099
(0.0151) (0.0153) (0.0153) (0.0199)
Family Alpha 0.0498* -0.1076* -0.1235** -0.1528**
(0.0292) (0.0613) (0.0620) (0.0729)
Star Manager 0.0012* 0.0000
(0.0007) (0.0010)
Obj Flow 0.3922*** 0.4636*** 0.4639*** 0.5230***
(0.0792) (0.0830) (0.0830) (0.0904)
Constant 0.0035 0.0072 0.0065 0.0168
(0.0078) (0.0081) (0.0081) (0.0104)

Observations 12,573 10,943 10,943 10,943

R2 0.325 0.328 0.329 0.346
Family FE No No No Yes
Past Flows Yes Yes Yes Yes
Year-Month FE Yes Yes Yes Yes


 Table VI
Placebo Tests: Flow-Performance Regression in Funds Managed by Different Managers

This table presents results from flow-performance regressions, in which we use funds that are
managed by different managers. Columns (1) and (2) use the two funds (F1 and F2) in a period when
they are managed by different managers; Columns (3) and (4) replace one of the manager’s funds (F2)
with another fund that is in the same fund family or has similar characteristics but is not managed by
the same manager. The dependent variable is Flow. In Columns (2) and (4), we use a piecewise linear
specification. For each month, we rank each fund based on their alpha and assign a fractional Rank
from zero (worst) to one (best). We then define Low Alpha = Min(Rank, 0.2), Mid Alpha = Min(0.6,
Rank – Low Alpha), and High Alpha = Rank – Mid Alpha – Low Alpha. We present results using OLS
with errors clustered at the manager level. All other variables are defined in Table XIII. *, **, and ***
denote 10%, 5%, and 1% significance, respectively.


 (1) (2) (3) (4)

Alpha 0.4684*** 0.4997***

(0.0492) (0.0482)
Alpha2 -0.0909* -0.0538
(0.0470) (0.0376)
Low Alpha 0.0213*** 0.0220***
(0.0072) (0.0059)
Mid Alpha 0.0097*** 0.0084***
(0.0016) (0.0015)
High Alpha 0.0296*** 0.0423***
(0.0088) (0.0089)
Low Alpha2 -0.0022 0.0024
(0.0071) (0.0078)
Mid Alpha2 -0.0004 -0.0018
(0.0019) (0.0014)
High Alpha2 -0.0112 -0.0048
(0.0075) (0.0055)
ln (Age) -0.0009* -0.0009* -0.0009** -0.0009**
(0.0005) (0.0005) (0.0004) (0.0004)
ln (FundSize) -0.0010*** -0.0010*** -0.0002 -0.0001
(0.0002) (0.0002) (0.0002) (0.0002)
Expense -0.0025 0.0110 0.0126 0.0185
(0.0589) (0.0582) (0.0579) (0.0592)
Stdret -0.0502*** -0.0432** -0.0564*** -0.0559***
(0.0166) (0.0172) (0.0179) (0.0169)
Obj Flow 0.5293*** 0.5288*** 0.3542*** 0.3479***
(0.0795) (0.0787) (0.0615) (0.0616)
Constant 0.0115 0.0050 0.0152* 0.0071
(0.0184) (0.0185) (0.0081) (0.0081)

Observations 17,582 17,582 18,876 18,876

R2 0.346 0.346 0.359 0.359
Past Flows Yes Yes Yes Yes
Manager FE No No No No
Year-Month FE Yes Yes Yes Yes


 Table VII
Portfolios Formed Based on Past Performance in the Other Fund

In this table, portfolios are formed using Fund 2 of the manager. We sort all Fund 2s into quintiles
based on the past 12-month Carhart (1997) alpha of the manager’s Fund 1. Panel A sorts Fund 2s on
the after-fee alpha of Fund 1, and Panel B sorts on the before-fee alpha of Fund 1. In each quintile,
portfolios are rebalanced monthly and held for different time horizons t: 1 month, 3 months, 6
months, and 12 months. The portfolio returns are the cumulative after-fee returns of Fund 2s in the
corresponding quintile. The portfolio alphas, reported in the table, are calculated by regressing the
portfolio returns on Carhart (1997) four factors using the full sample period. We use Newey-West
(1987) standard errors with three lags; t-statistics are presented in parentheses. *, **, and *** denote
10%, 5%, and 1% significance, respectively.

Holding
Period 1-month 3-month 6-month 12-month
Quintiles Alpha t-stat Alpha t-stat Alpha t-stat Alpha t-stat
Panel A: Sorted on Past Alpha of Fund 1 (After Fees)
1 (Lowest) -0.0028** (-2.18) -0.0023* (-1.90) -0.0022* (-1.77) -0.0013 (-1.16)
2 -0.0012 (-1.53) -0.0012 (-1.56) -0.0011 (-1.60) -0.0011 (-1.62)
3 -0.0003 (-0.31) -0.0005 (-0.68) -0.0007 (-1.13) -0.0008 (-1.35)
4 -0.0004 (-0.48) -0.0004 (-0.57) -0.0004 (-0.49) -0.0004 (-0.51)
5 (Highest) 0.0019* (1.82) 0.0018* (1.68) 0.0014 (1.31) 0.0005 (0.51)
5-1 0.0047*** (3.95) 0.0042*** (3.60) 0.0035*** (3.38) 0.0019* (1.89)
Panel B: Sorted on Past Alpha of Fund 1 (Before Fees)
1 (Lowest) -0.0025** (-2.02) -0.0022* (-1.77) -0.0021* (-1.75) -0.0013 (-1.15)
2 -0.0014* (-1.69) -0.0012 (-1.48) -0.0010 (-1.40) -0.0010 (-1.50)
3 -0.0005 (-0.52) -0.0007 (-1.05) -0.0009 (-1.44) -0.0009 (-1.40)
4 -0.0002 (-0.30) -0.0004 (-0.54) -0.0003 (-0.40) -0.0004 (-0.54)
5 (Highest) 0.0018* (1.64) 0.0017 (1.59) 0.0013 (1.19) 0.0005 (0.49)
5-1 0.0043*** (3.75) 0.0039*** (3.46) 0.0034*** (3.29) 0.0018* (1.88)


 Table VIII
Portfolios Formed Based on Past Performance in Both Funds and Basic Checks

In this table, portfolios are formed using Fund 2 of the manager. First, we sort all Fund 2s into terciles
based on their past 12-month performance (Perf2). Within each tercile of Perf2, we sort all funds into
quintiles based on the past 12-month performance of the manager’s Fund 1 (Perf1). All sorting is
performed using returns after fees. Finally, we take the equally weighted average return of Fund 2s
across the Perf2 terciles. Since we use conditional double sorts, the equal-weighted returns to each
quintile of past Perf1 now controls for own-fund return predictability.

In each quintile, portfolios are rebalanced monthly and held for different time horizons t: 1 month, 3
months, 6 months, and 12 months. The portfolio returns are the cumulative after-fee returns of Fund
2s in the corresponding quintile. Panel A presents alphas estimated with the Carhart (1997) four-factor
model (both portfolio returns and past performance measures are four-factor alphas). We then present
alphas from alternative models. In Panel B we include the Pastor and Stambaugh (2003) liquidity factor
and in Panel C we include the short-term and long-term reversal factors obtained from Prof. Kenneth
French’s website. Panel D reports results with four-factor alphas where portfolios are formed by
sorting on style-adjusted returns, while Panel E reports results with style-adjusted returns where
portfolios are formed by sorting on four-factor alphas. We use Newey-West (1987) standard errors
with three lags; t-statistics are presented in parentheses. *, **, and *** denote 10%, 5%, and 1%
significance, respectively.

Holding
Period 1-month 3-month 6-month 12-month
Quintiles Alpha t-stat Alpha t-stat Alpha t-stat Alpha t-stat
Panel A: Conditional Double Sorts: Using 4-Factor Alphas
1 (Lowest) -0.0011 (-0.88) -0.0010 (-0.81) -0.0009 (-0.75) -0.0005 (-0.46)
2 -0.0014** (-2.08) -0.0012* (-1.80) -0.0011* (-1.66) -0.0009 (-1.28)
3 -0.0004 (-0.47) -0.0008 (-1.15) -0.0009 (-1.36) -0.0008 (-1.27)
4 -0.0013* (-1.70) -0.0008 (-0.95) -0.0009 (-1.22) -0.0009 (-1.25)
5 (Highest) 0.0017* (1.73) 0.0013 (1.51) 0.0008 (1.03) 0.0001 (0.04)
5-1 0.0028** (2.37) 0.0023** (2.02) 0.0017* (1.74) 0.0005 (0.56)
Panel B: Conditional Double Sorts: Using 5-Factor Alphas
1 (Lowest) -0.0012 (-0.98) -0.0012 (-1.00) -0.0011 (-0.97) -0.0007 (-0.75)
2 -0.0016** (-2.24) -0.0013** (-1.98) -0.0012* (-1.87) -0.0010 (-1.42)
3 -0.0006 (-0.68) -0.0009 (-1.28) -0.0009 (-1.51) -0.0009 (-1.56)
4 -0.0015* (-1.85) -0.0010 (-1.18) -0.0011 (-1.52) -0.0012 (-1.59)
5 (Highest) 0.0017* (1.68) 0.0012 (1.41) 0.0007 (0.86) -0.0001 (-0.17)
5-1 0.0029** (2.24) 0.0024** (2.01) 0.0018* (1.79) 0.0006 (0.68)


 

Holding
Period 1-month 3-month 6-month 12-month
Quintiles Alpha t-stat Alpha t-stat Alpha t-stat Alpha t-stat
Panel C: Conditional Double Sorts: Using 7-Factor Alphas
1 (Lowest) -0.0009 (-0.83) -0.0009 (-0.86) -0.0009 (-0.85) -0.0006 (-0.61)
2 -0.0015** (-2.10) -0.0013* (-1.85) -0.0012* (-1.73) -0.0009 (-1.31)
3 -0.0006 (-0.64) -0.0008 (-1.20) -0.0009 (-1.38) -0.0008 (-1.42)
4 -0.0013* (-1.64) -0.0008 (-0.99) -0.0010 (-1.35) -0.0011 (-1.45)
5 (Highest) 0.0018* (1.90) 0.0013 (1.60) 0.0009 (1.08) 0.0001 (0.02)
5-1 0.0027** (2.35) 0.0023** (2.07) 0.0018* (1.83) 0.0006 (0.66)
Panel D: Conditional Double Sorts: Sorting on Style-Adjusted Returns
1 (Lowest) -0.0021* (-1.94) -0.0024** (-2.08) -0.0027* (-2.33) -0.0027** (-2.33)
2 -0.0023** (-2.36) -0.0018* (-1.73) -0.0013 (-1.23) -0.0013 (-1.23)
3 -0.0012 (-1.27) -0.0008 (-0.99) -0.0006 (-0.85) -0.0006 (-0.85)
4 0.0003 (0.42) -0.0002 (-0.23) -0.0004 (-0.49) -0.0004 (-0.49)
5 (Highest) -0.0001 (-0.09) -0.0004 (-0.43) -0.0006 (-0.76) -0.0006 (-0.76)
5-1 0.0020* (1.65) 0.0020* (1.83) 0.0021* (1.94) 0.0021* (1.94)
Style-Adj Style-Adj Style-Adj Style-Adj
Return Return Return Return
Panel E: Conditional Double Sorts: Sorting on 4-Factor Alphas
1 (Lowest) -0.0014* (-1.87) -0.0009 (-1.25) -0.0007* (-1.97) -0.0005 (-1.23)
2 -0.0016*** (-3.47) -0.0012*** (-2.83) -0.0013*** (-3.67) -0.0011*** (-2.59)
3 -0.0007 (-1.27) -0.0007* (-1.65) -0.0011* (-1.82) -0.0008 (-1.41)
4 -0.0012** (-2.13) -0.0007 (-1.41) -0.0005 (-1.15) -0.0005 (-1.27)
5 (Highest) 0.0004 (0.65) 0.0006 (1.58) 0.0001 (0.19) -0.0003 (-0.53)
5-1 0.0018* (1.81) 0.0014* (1.65) 0.0009 (1.62) 0.0002 (0.53)



 Table IX
Portfolios Formed Based on Past Performance in Both Funds: Additional Checks

In this table, we present additional checks for the conditional double-sort results presented in Table
VIII. Panel A reports results at longer horizons: 15 months, 18 months, 21 months, and 24 months
(all skipping the most recent six months). In Panels B and C, we report double-sort results using our
placebo samples, that is, samples of funds that are managed by different managers. Panel B uses the
two funds (F1 and F2) in a period when they are managed by different managers; Panel C replaces
one of the manager’s funds (F2) with another fund that is in the same fund family or has similar
characteristics but is not managed by the same manager. We use Newey-West (1987) standard errors
with three lags; t-statistics are presented in parentheses. *, **, and *** denote 10%, 5%, and 1%
significance, respectively.

Holding
Period 15-month 18-month 21-month 24-month
Quintiles Alpha t-stat Alpha t-stat Alpha t-stat Alpha t-stat
Panel A: Conditional Double Sorts: In Subsequent Horizons (Skipping the Most Recent 6 Months)
1 (Lowest) 0.0001 (0.14) 0.0002 (0.16) 0.0002 (0.16) 0.0000 (0.02)
2 -0.0007 (-0.86) -0.0005 (-0.61) -0.0005 (-0.65) -0.0006 (-0.80)
3 -0.0009 (-1.29) -0.0009 (-1.34) -0.0009 (-1.42) -0.0009 (-1.42)
4 -0.0007 (-0.82) -0.0008 (-1.01) -0.0008 (-1.16) -0.0007 (-1.04)
5 (Highest) 0.0001 (0.14) 0.0001 (0.14) 0.0002 (0.19) 0.0003 (0.31)
5-1 -0.0000 (-0.02) -0.0001 (-0.05) -0.0000 (-0.01) 0.0002 (0.24)
Holding
Period 1-month 3-month 6-month 12-month
Panel B: Conditional Double Sorts: Using Placebo Sample 1
1 (Lowest) -0.0009 (-0.65) -0.0009 (-0.73) -0.0010 (-0.84) -0.0005 (-0.48)
2 -0.0006 (-0.56) -0.0009 (-0.89) -0.0015 (-1.59) -0.0012 (-1.31)
3 -0.0009 (-1.05) -0.0004 (-0.46) -0.0006 (-0.78) -0.0005 (-0.55)
4 -0.0005 (-0.54) -0.0008 (-0.87) -0.0005 (-0.51) -0.0002 (-0.23)
5 (Highest) 0.0005 (0.37) -0.0006 (-0.46) -0.0004 (-0.31) -0.0008 (-0.67)
5-1 0.0014 (0.76) 0.0003 (0.20) 0.0006 (0.60) -0.0002 (-0.23)
Panel C: Conditional Double Sorts: Using Placebo Sample 2
1 (Lowest) 0.0001 (0.00) -0.0001 (-0.08) -0.0006 (-0.58) -0.0006 (-0.58)
2 -0.0012 (-1.19) -0.0008 (-0.93) -0.0009 (-1.14) -0.0009 (-1.14)
3 -0.0014 (-1.44) -0.0011 (-1.36) -0.0009 (-1.28) -0.0009 (-1.28)
4 -0.0013 (-1.46) -0.0012* (-1.66) -0.0006 (-0.77) -0.0006 (-0.77)
5 (Highest) 0.0018 (1.56) 0.0008 (0.82) 0.0006 (0.81) 0.0006 (0.81)
5-1 0.0018 (1.37) 0.0009 (0.96) 0.0012 (1.55) 0.0012 (1.55)


 Table X
Regression of Future Performance on Past Performance

This table presents results of the predictive regressions of future performance on past performance.
The dependent variable is Style-Adjusted Return. Alpha and Alpha2 are the risk-adjusted returns
estimated using Carhart (1997) four-factor model, and AlphaRank and Alpha2Rank are fractional
performance ranks based on Alpha and Alpha2 ranging from zero (worst) to one (best). LowRank and
Low2Rank indicate, respectively, that the own fund and the other fund are in the lowest two
performance quintiles. Alpha rank variables are interacted with the dummy variables Uncommon,
indicating that the two funds’ portfolio overlap is below the sample median, and Highcorr, indicating
that the correlation of the two funds’ past four-factor risk-adjusted return is above the sample median.
We present Fama-Macbeth (1973) estimates with Newey-West (1987) standard errors. All other
variables are defined in Table XIII. *, **, and *** denote 10%, 5%, and 1% significance, respectively.
(1) (2) (3) (4)

AlphaRank 0.0037** 0.0035*** 0.0039***

(0.0015) (0.0013) (0.0012)
Alpha2Rank 0.0030*** 0.0012 0.0047**
(0.0011) (0.0016) (0.0024)
LowRank -0.0010
(0.0007)
Low2Rank -0.0016***
(0.0006)
Alpha2Rank x Uncommon 0.0032*
(0.0017)
Alpha2Rank x Highcorr -0.0022
(0.0025)
Uncommon -0.0001
(0.0012)
Highcorr 0.0002
(0.0016)
ln (Age) 0.0001 0.0001 -0.0001 0.0002
(0.0005) (0.0005) (0.0005) (0.0005)
ln (FundSize) -0.0004** -0.0004** -0.0003 -0.0004**
(0.0002) (0.0002) (0.0002) (0.0002)
Expense -0.0613 -0.0789** -0.0739* -0.0488
(0.0381) (0.0381) (0.0394) (0.0354)
Stdret 0.0806 0.0901 0.0779 0.0820
(0.0632) (0.0653) (0.0732) (0.0644)
Obj flow -0.0114 0.0371 -0.1555 -0.0175
(0.1745) (0.1819) (0.1822) (0.1715)
Constant -0.0030 0.0018 -0.0024 -0.0037
(0.0037) (0.0038) (0.0039) (0.0041)

Observations 19,318 19,318 17,706 19,318

R2 0.379 0.367 0.436 0.414
Past Flows Yes Yes Yes Yes


 Table XI
Regression of Future Performance on Past Performance: Role of Frictions

This table presents results of the predictive regressions of future performance on past performance.
The dependent variable is Style-Adjusted Return. Alpha and Alpha2 are the risk-adjusted returns
estimated using the Carhart (1997) four-factor model, and AlphaRank and Alpha2Rank are fractional
performance ranks based on Alpha and Alpha2 ranging from zero (worst) to one (best). Loads is a
dummy variable that indicates whether the fund has front-end or back-end loads. The dummy variable
High12b1 indicates high 12b-1 fees charged by the other fund (in the top tercile of the sample). We
present Fama-Macbeth (1973) estimates with Newey-West (1987) standard errors. All other variables
are defined in Table XIII. *, **, and *** denote 10%, 5%, and 1% significance, respectively.

(1) (2)

AlphaRank 0.0038** 0.0031*

(0.0015) (0.0018)
Alpha2Rank 0.0027** 0.0038**
(0.0013) (0.0017)
Alpha2Rank x Loads 0.0016
(0.0016)
Alpha2Rank x High12b1 -0.0039*
(0.0023)
Loads -0.0007
(0.0009)
High12b1 0.0021
(0.0015)
ln (Age) -0.0001 -0.0004
(0.0005) (0.0005)
ln (FundSize) -0.0004* -0.0001
(0.0002) (0.0002)
Expense -0.0640 -0.0668*
(0.0422) (0.0373)
Stdret 0.0740 0.0792
(0.0645) (0.0703)
Obj flow -0.0931 -0.1984
(0.1605) (0.1713)
Constant -0.0019 -0.0030
(0.0034) (0.0044)

Observations 19,318 14,104

R2 0.402 0.506
Past Flows Yes Yes


 Table XII
Flow-Performance Regression in Multi-Funds: Role of Frictions

This table presents results from flow-performance regressions, interacting alphas with Loads and
High12b1. Loads is a dummy variable that indicates whether the fund has any front-end or back-end
loads. The dummy variable High12b1 indicates high 12b-1 fees charged by the other fund (in the top
tercile of the sample). The dependent variable is Flow. Alpha and Alpha2 are the risk-adjusted returns
of the fund and the other fund, respectively. We present results using OLS with errors clustered at
the manager level. Variable definitions are in Table XIII. *, **, and *** denote 10%, 5%, and 1%
significance, respectively.

(1) (2)

Alpha 0.4122*** 0.5754***

(0.0496) (0.0622)
Alpha2 0.0787* 0.0163
(0.0425) (0.0606)
Alpha2 x Loads -0.0342**
(0.0171)
Alpha2 x High12b1 0.1749*
(0.0996)
Loads -0.0008
(0.0007)
High12b1 0.0015*
(0.0008)
ln (Age) -0.0008** -0.0010**
(0.0004) (0.0004)
ln (FundSize) -0.0003* -0.0006**
(0.0002) (0.0002)
Expense 0.1199* 0.0500
(0.0687) (0.0707)
Stdret -0.0328* -0.0568***
(0.0176) (0.0188)
Obj Flow 0.2761*** 0.3184***
(0.0536) (0.0612)
Constant 0.0064 0.0127**
(0.0046) (0.0057)

Observations 19,538 14,265

R2 0.365 0.377
Past Flows Yes Yes
Year-Month FE Yes Yes


 Table XIII
Variable Definitions

Variable Definition
Flow Proportional monthly growth in total assets under management.
Alpha, Alpha2 Risk-adjusted return over the past 12 months, estimated using the Carhart (1997)
four-factor model. 2 denotes the other fund.
Low Alpha, Low Alpha2 For each month, a fractional rank (Rank) from zero (worst) to one (best) is assigned
to each fund based on Alpha. Low Alpha = Min(Rank , 0.2). 2 denotes the other
fund.
Mid Alpha, Mid Alpha2 Mid Alpha = Min(0.6, Rank – Low Alpha). 2 denotes the other fund.
High Alpha, High Alpha2 High Alpha = Rank – Mid Alpha – Low Alpha. 2 denotes the other fund.
Stdret Standard deviation of fund raw returns over the past 12 months.
ln (Age) Natural logarithm of (1+ fund age).
ln (FundSize) Natural logarithm of the fund’s total net assets under management.
Expense Expense ratio plus one-seventh of the front-end load.
Obj Flow Total monthly flows into the corresponding objective of the fund.
StyleRank A dummy variable that indicates Style Difference is above the historical median,
where Style Difference is the sum of the absolute percentage differences of the
Carhart (1997) four-factor loadings between the two funds.
VolRank, Vol2Rank A dummy variable that indicates Stdret is above the sample median. 2 denotes the
other fund.
OneVolatileFund In every month, all managers are ranked based on whether they have at least one
fund with VolRank = 1. OneVolatileFund is a dummy variable that indicates the
manager ranks above the median manager.
TimeManageRank A dummy variable that indicates the latter half of the manager’s tenure in the fund
pair.
Family Alpha Average Alpha of all funds in the family, excluding Fund 1 (or excluding Fund 1
and Fund 2).
Star Manager A dummy variable that represents stellar performance (top 5% based on past alpha)
of other funds in the family, following Nanda, Wang, and Zheng (2004).
Style Adjusted Return The raw return minus the average return on all funds in the corresponding
objective.
AlphaRank, Alpha2Rank For each month, a fractional rank (Rank) from zero (worst) to one (best) is assigned
to each fund based on Alpha. 2 denotes the other fund.
LowRank, Low2Rank A dummy variable that indicates Rank is in the lowest two quintiles. 2 denotes the
other fund.
Uncommon A dummy variable that indicates the two funds’ portfolio overlap is below the
sample median.
Highcorr A dummy variable that indicates the correlation of the two funds’ past four-factor
risk-adjusted return is above the sample median.
Loads A dummy variable that indicates the fund has front-end or back-end loads.


High12b1 A dummy variable that indicates high 12b-1 fees charged by the other fund (in the
top tercile of the sample).