Don’t Take Their Word For It: The Misclassification of Bond Mutual Funds

Huaizhi Chen, Lauren Cohen and Umit Gurun

No 26423, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We provide evidence that bond fund managers misclassify their holdings, and that these misclassifications have a real and significant impact on investor capital flows. In particular, many funds report more investment grade assets than are actually held in their portfolios to important information intermediaries, making these funds appear significantly less risky. This results in pervasive misclassification across the universe of US fixed income mutual funds. The problem is widespread - resulting in up to 31.4% of funds being misclassified with safer profiles, when compared against their true, publicly reported holdings. “Misclassified funds” – i.e., those that hold risky bonds, but claim to hold safer bonds – appear to on-average outperform the low-risk funds in their peer groups. Within category groups, “Misclassified funds” moreover receive higher Morningstar Ratings (significantly more Morningstar Stars) and higher investor flows due to this perceived on-average outperformance. However, when we correctly classify them based on their actual risk, these funds are mediocre performers. These Misclassified funds also significantly underperform precisely when junk-bonds crash in returns. Misreporting is stronger following several quarters of large negative returns.

JEL-codes: G11 G12 G23 G24 G4 K0 (search for similar items in EconPapers)
Date: 2019-11
New Economics Papers: this item is included in nep-fmk
Note: AP CF LE
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Citations: View citations in EconPapers (8)

Published as HUAIZHI CHEN & LAUREN COHEN & UMIT G. GURUN, 2021. "Don't Take Their Word for It: The Misclassification of Bond Mutual Funds," The Journal of Finance, vol 76(4), pages 1699-1730.

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