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Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds

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Author Info
Zitzewitz, Eric (Stanford U)

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Abstract

As is becoming increasingly widely known, mutual funds often calculate their net asset values using stale prices, which causes their daily returns to be predictable. By trading on this predictability, investors can earn 35-70 percent per year in international funds and 10-25 percent in asset classes such as small-cap equity and high-yield and convertible bonds. These abnormal returns come at the expense of long-term share-holders, dilution of whom has grown in international funds from 56 basis points in 1998-9 to 114 basis points in 2001. Despite these losses and pressure from the SEC, the vast majority of funds are not market-updating their prices to eliminate NAV predictability and dilution, but are instead pursuing solutions that are only partly effective. The speed and ecacy of a fund's actions to protect shareholders from dilution is negatively correlated with its expense ratios and the share of insiders on its board, suggesting that agency problems may be the root cause of the arbitrage problem.

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Paper provided by Stanford University, Graduate School of Business in its series Research Papers with number 1749.

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Date of creation: Oct 2002
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Handle: RePEc:ecl:stabus:1749

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. K. Geert Rouwenhorst & William N. Goetzmann & Zoran Ivkovich, 2000. "Day Trading International Mutual Funds: Evidence And Policy Solutions," Yale School of Management Working Papers ysm138, Yale School of Management. [Downloadable!]
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  2. Bhargava, Rahul & Dubofsky, David A., 2001. "A note on fair value pricing of mutual funds," Journal of Banking & Finance, Elsevier, vol. 25(2), pages 339-354, February. [Downloadable!] (restricted)
  3. Stephen J. Brown & William N. Goetzmann & Takato Hiraki & Noriyoshi Shirishi & Masahiro Watanabe, 2003. "Investor Sentiment in Japanese and U.S. Daily Mutual Fund Flows," NBER Working Papers 9470, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Lo, Andrew W. & Craig MacKinlay, A., 1990. "An econometric analysis of nonsynchronous trading," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 181-211. [Downloadable!] (restricted)
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  5. William N. Goetzmann & Massimo Massa & K. Geert Rouwenhorst, 2000. "Behavioral Factors in Mutual Fund Flows," Yale School of Management Working Papers ysm135, Yale School of Management. [Downloadable!]
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  6. Robert F. Engle & Takatoshi Ito & Wen-Ling Lin, 1991. "Meteor Showers or Heat Waves? Heteroskedastic Intra-Daily Volatility in the Foreign Exchange Market," NBER Working Papers 2609, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Wen-Ling Lin & Robert F. Engle & Takatoshi Ito, 1991. "Do Bulls and Bears Move Across Borders? International Transmission of Stock Returns and Volatility as the World Turns," NBER Working Papers 3911, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Eun, Cheol S. & Shim, Sangdal, 1989. "International Transmission of Stock Market Movements," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(02), pages 241-256, June. [Downloadable!]
  9. Lin, Wen-Ling & Engle, Robert F & Ito, Takatoshi, 1994. "Do Bulls and Bears Move across Borders? International Transmission of Stock Returns and Volatility," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 7(3), pages 507-38. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Guido Palazzo & Lena Rethel, 2008. "Conflicts of Interest in Financial Intermediation," Journal of Business Ethics, Springer, vol. 81(1), pages 193-207, August. [Downloadable!] (restricted)
  2. Khorana, Ajay & Servaes, Henri & Wedge, Lei, 2006. "Portfolio Manager Ownership and Fund Performance," CEPR Discussion Papers 5931, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Stephen J. Brown & William N. Goetzmann & Takato Hiraki & Noriyoshi Shirishi & Masahiro Watanabe, 2003. "Investor Sentiment in Japanese and U.S. Daily Mutual Fund Flows," NBER Working Papers 9470, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  4. Eric Zitzewitz, 2005. "How Widespread is Late Trading in Mutual Funds?," Finance 0501002, EconWPA. [Downloadable!]
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  5. Marcin Kacperczyk & Clemens Sialm & Lu Zheng, 2005. "Unobserved Actions of Mutual Funds," NBER Working Papers 11766, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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