In a recent article for the Journal of Finance, Travis Sapp and Ashish Tawari investigate the “smart money” effect. Mutual funds with positive money flow perform better in the short term than do funds with negative money flow, suggesting good fund selection ability on the part of investors. The authors conclude that:
- The outperformance of funds with large current cash inflows is due to the momentum of prior investments. Outperforming funds hold high concentrations of recent winning stocks subject to mechanical momentum trading styles.
- New inflows to outperforming funds are simply responses to recent large returns. These inflows are not based on systematic momentum investing analysis or on identification of superior fund managers.
In summary, mutual fund inflows naively chase past returns.
