Seasonal Asset Allocation: Evidence from Mutual Fund Flows

A large body of research studies the relation between past mutual fund performance and investor flows. In this paper, we document a strong seasonality in mutual fund flows. While some of this seasonality is related to other influences, we find a strong relation between investor flows and seasonally varying riskaversion that is consistent with some investors experiencing seasonal affective disorder (SAD). Specifically, consistent with seasonally varying risk-aversion, our paper shows that substantial money moves from equity to government money market mutual funds in the fall, then back to equity funds in the spring, controlling for the influence of past performance, advertising, and capital gains overhang on fund flows. While prior evidence regarding the influence of SAD relies on seasonal patterns in the returns of asset classes, our paper provides the first direct trade-related evidence. Several prior papers have uncovered strong predictability in mutual fund flows. For example, individuals invest heavily in funds with the highest prior-year returns, and disinvest weakly from funds with the lowest returns (Sirri and Tufano, 1998; Chevalier and Ellison, 1997; and Lynch and Musto, 2003). This returnchasing behavior indicates that individuals infer investment management quality from past performance, especially for past winning funds. More recently, Ben-Rephael, Kandel, and Wohl (2010a) show that net exchanges of money from US bond to US equity funds are strongly positively correlated with past equity market excess returns, with a strong return reversal in equities during the following several months.1 Their findings support the view that fund exchanges reflect small investor sentiment. Indro (2004) also finds evidence consistent with equity fund flows being driven by investor sentiment. Further, Ben-Rephael, Kandel, and Wohl (2010b) examine daily equity fund flows in Israel and find strong autocorrelation in mutual fund flows as well as a strong correlation of flows with lagged market returns, which appear to create a temporary price pressure. Investors also react strongly to advertising of funds (Jain and Wu, 2000; and Gallaher, Kaniel, and Starks, 2006) and to other information that helps to reduce search costs (Huang, Wei, and Yan, 2007). In turn, the mutual fund industry spends more than half a billion dollars a year on advertising to attract investment inflows (see Pozen, 2002). The benefits of attracting capital flows for mutual fund management companies are clear: in 2008, fund shareholders in the United States paid fees and expenses of 1.02 percent on equity funds and 0.79 percent on bond funds – with 6.5 and 1.7 trillion dollars under management in all US-domiciled equity and bond mutual funds, respectively (Investment Company Institute, 2008). In this study, we document a heretofore unknown seasonality in mutual fund flows. Some of this seasonality is related to seasonalities in advertising expenditures, tax avoidance, and liquidity needs. However, we show that flows to funds, controlling for these influences (and others), remain strongly dependent on the season as well as the riskiness of the fund. Investors move money into (relatively) safe funds during the fall, and into risky funds during the spring. This seasonality coincides in timing with risk-aversion driven by a medical condition known as seasonal affective disorder, or SAD, which is a seasonal form of depression.2 Exchanges are movements of money between funds within a single fund family. Medical evidence firmly demonstrates that as the number of hours of daylight drops in the fall, up to ten percent of the population suffers from clinical depression associated with SAD, depending on the location and the methodology employed by the researchers. (Some studies find the incidence of SAD is as high as ten percent, such as Rosen et al.’s (1990) analysis of a sample in New Hampshire, while others find it is below two percent, such as Rosen et al.’s study of a sample in Florida.) The