Why are investors’ mutual fund market allocations far from optimal?

Ricardo Laborda; Ramiro Losada

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We investigate the difference between the optimal portfolio of funds that rational investors may would take under complete information and the actual structure of the mutual fund markets depending on the type of investor at which a fund is aimed, retail vs. wholesale, and the fund’s risk profile, conservative vs. more aggressive.
We find that, with the exception of the fees, the relationship between the age of the fund, market share and the change in the fund’s total net assets and the optimal portfolio of funds depends on the mutual fund market structure.
Although the feasibility of achieving the optimal portfolio is difficult due to the presence of frictions, especially short-selling restrictions and search costs, it would be possible to improve the investor’s market allocation by providing easier access to information about a few fund characteristics, like fees, age, market share or investors’ flows.

Abstract

In this paper, we analyze the differences between an optimal portfolio of funds that an investor may take under complete information and the actual structure of the mutual fund market characterized by a fund’s risk profile (conservative or aggressive) as well as the type of investor (retail or wholesale) at which a fund is aimed. We find that, with the exception of the fees, the relationship between the fund age, the market share and the change in the fund’s total net assets and the optimal portfolio of funds depends on the mutual fund market structure.

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