Mutual Fund Flows and Investor Disappointment

Increased mutual fund flows after high returns are partially reversed at longer horizons, attributable to greater outflows not reduced inflows. We test theories with potential to explain this reversal: investment lifecycles, tax loss selling, and a “disappointment” hypothesis that is based on overreactions by some investors to recent positive returns. While tax loss selling contributes to explaining outflows, the evidence supports a role for investor disappointment. As predicted, outflow coefficients are positive when recent returns are normal, and outflow magnitudes depend on recent returns relative to the prior returns that attracted inflows, after allowing for direct effects of recent returns.