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Ponzi Funds

Author

Listed:
  • Philippe van der Beck
  • Jean-Philippe Bouchaud
  • Dario Villamaina

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.

Suggested Citation

  • Philippe van der Beck & Jean-Philippe Bouchaud & Dario Villamaina, 2024. "Ponzi Funds," Papers 2405.12768, arXiv.org.
  • Handle: RePEc:arx:papers:2405.12768
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    References listed on IDEAS

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