Ponzi Funds

Philippe van der Beck, Jean-Philippe Bouchaud and Dario Villamaina

Papers from arXiv.org

Abstract: Many active funds hold concentrated portfolios. Flow-driven trading in these securities causes price pressure, which pushes up the funds' existing positions resulting in realized returns. We decompose fund returns into a price pressure (self-inflated) and a fundamental component and show that when allocating capital across funds, investors are unable to identify whether realized returns are self-inflated or fundamental. Because investors chase self-inflated fund returns at a high frequency, even short-lived impact meaningfully affects fund flows at longer time scales. The combination of price impact and return chasing causes an endogenous feedback loop and a reallocation of wealth to early fund investors, which unravels once the price pressure reverts. We find that flows chasing self-inflated returns predict bubbles in ETFs and their subsequent crashes, and lead to a daily wealth reallocation of 500 Million from ETFs alone. We provide a simple regulatory reporting measure -- fund illiquidity -- which captures a fund's potential for self-inflated returns.

Date: 2024-05
New Economics Papers: this item is included in nep-fmk and nep-mst
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