Economics at your fingertips  

Is prior performance priced through closed-end fund discounts?

Michael Bleaney and Richard Smith ()

International Journal of Finance & Economics, 2010, vol. 15, issue 2, 153-164

Abstract: In open-end mutual funds (unit trusts), there is a strong positive cross-sectional relationship between net inflows to individual funds and past performance, as if investors attributed performance to managerial skill. Performance shows only very weak persistence, however, so at first sight investors do not appear to gain anything by responding to past performance information. This behaviour can be explained by the fact that past performance is effectively unpriced in the unit trust market, since management fees are unresponsive to demand. If investors believe that there is a non-zero probability that future performance will turn out to be positively correlated with past performance (i.e. that there is an element of managerial skill in performance), but a zero probability that this correlation will be negative, it is rational to prefer funds with better past performance when performance is not priced. In other words, it costs nothing to insure against the possibility of some managerial skill effect. If this explanation of the flow-performance relationship in unit trusts is correct, one would expect the relationship between investor demand and past fund performance to be much weaker if past performance were to be priced. We test this hypothesis in the market for closed-end funds (investment trusts). Because closed-end funds do not trade at net asset value, but at a price determined in the market, strong demand will raise the ratio of price to net asset value (known as the premium). Since it is well established that premiums are mean-reverting, future shareholder returns on funds currently on high premiums tend to be depressed by the reversion of the premium to the mean. In the closed-end fund market, as for open-end funds, there is little evidence of performance persistence, and therefore, to the extent that funds with good past performance are pushed to higher premiums, the expected return on them is less than on the average fund. This implicit pricing mechanism should mean that demand is a declining function of the premium, so that, even if demand is an increasing function of past performance for a given premium, any effect on the premium itself will be muted. We test this hypothesis for closed-end funds traded in the US and the UK. We find that there is a statistically significant effect of past performance on the premium in both countries. However, consistent with the hypothesis, it has limited economic significance, since it represents only a small component of premium variability. Copyright © 2008 John Wiley & Sons, Ltd.

Date: 2010
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link) Link to full text; subscription required (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link:

Ordering information: This journal article can be ordered from
http://jws-edcv.wile ... PRINT_ISSN=1076-9307

Access Statistics for this article

International Journal of Finance & Economics is currently edited by Mark P. Taylor, Keith Cuthbertson and Michael P. Dooley

More articles in International Journal of Finance & Economics from John Wiley & Sons, Ltd.
Bibliographic data for series maintained by Wiley-Blackwell Digital Licensing ().

Page updated 2020-01-08
Handle: RePEc:ijf:ijfiec:v:15:y:2010:i:2:p:153-164