CHAPTER 1- INTRODUCTION 1.1 Research Background
During the period of 2001 to 2011, there are average 623 newly issued funds annually, which is over 7% of existing funds. Newly issued funds bring a lot of cash flows for fund industry. However, there are also about 600 funds liquidated or merged by other funds annually in fund industry, including numerous funds which are just launched for one or two years (Investment Company Fact Book, 2012). In other words, there are a lot of funds entering and exiting the market every year.
The purpose of this study is to examine the factors that affect the survival of newly issued mutual funds.
Furthermore, newly issued funds have several features. First, after launched, newly issued funds have to strive to rapidly attract as much cash flow as they can, since the major factor which directly affects the survival of newly issued funds is how much “cash flow” a new fund contributes to its fund family or fund manager. Cash flows is very important to mutual funds because it is related to fund assets and thus affects the market shares of fund families as well as the revenues of fund companies which is a function of assets under management (Khorana and Servaes, 2011); therefore, if newly issued funds fail to bring cash flows to themselves or their fund families, they may encounter the faith of liquidation or being merged by other funds. Second, due to the homogeneity of fund industry, after a huge fund innovation such as brand extension (launch new type of funds different from current type in fund family) and product improvement (launch funds with new investment objectives, investment styles, and investment subjects), “price complexity” becomes the major factor that influences competition and success of a new fund (Carlin, 2009). Fund companies adjust fee structure to meet the demand of different investors and enhance the competitive capability of funds. Third, there are some different features between existed funds and newly issued funds which may lead to different effects of fee strategies on the cash flows of funds. For instance, in the initial period, newly issued funds neither reach a specific fund size, nor they have fund awareness. They also lack of past performance as a reference when investors evaluate whether they
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should buy these funds. Consequently, newly issued funds have to rely on intensely advertising and sales force to obtain the chance to attract investors. If they fail to catch the attention of investors, they will encounter the faith of being closed.
1.2 Objectives
Most of prior researches focus on the effect of fee structures on fund performance. Recently, there are some studies investigating the relation between the various fees and expense ratios as well as relation between fee structures and fund flows. For instance, Khorana and Servaes (2011) investigate the effect of fee structure on the market shares of fund families. However, few researches focus on new funds. In this study, we attempt to examine the factor responsible for the success of newly issued funds and compare which marketing tool can effectively bring cash flows to fund companies.
The first contribution of this paper is that we manually collect Google Search Volume Index (SVI) of 4,917 new funds openings over 2004 to 2012, to proxy for investor attention. Traditionally, when researchers investigate the attention of investors to securities or products, they use advertisement expenditures, newspaper headlines, or extreme returns (Da, Engelberg, and Gao, 2011). We propose that SVI provides a direct and quantitative measure for investor attention since this measure captures the extent to which a particular query term is searched for using the Google Search engine (Drake, Roulstone, and Thornock, 2011). We then compare the effects of different marketing vehicles on cash inflows of newly issued funds, where various marketing vehicles considered in the current study include fund advertisement proxy by 12b-1 fees, sales force proxy by fund loads, fund past performance, and internet search proxy by SVI. We document that advertisement and sale force are no longer the only effective channels through which new funds can increase publicity as well as fund cash inflows. We find that SVI is statistically positive related to the cash inflows and the survival probability of newly issued equity funds. The results suggest that increasing search volume in internet is important when fund companies launch a new fund and hence investor interaction with the Internet may offer a new perspective on the marketing and product distribution in mutual fund
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industry. To our best knowledge, the current paper is the first one using the “big data” to advance our understanding of investor collective behavior in the mutual fund industry.
Second, previous literature, such as Zheng (1999), investigates whether investors' purchasing decisions are able to predict funds' future performance, or whether investors are smart in selecting funds. We contribute to this topic by analyzing whether active investors who make mutual fund investment decisions themselves and search for information about funds via Internet during the decision-making process are smart investors. We find there is no statistically significant relation between SVI and future fund performance, indicating that the internet search is not smart search.
Furthermore, we find 12b-1 fees can help newly issued funds survive. On the other hand, Advertisement is more effective for high return funds and low return funds compared to funds with middle return. Advertisement also helps high return funds attract more cash flows. However, this effect is insignificant for low return funds. These results suggest that the fund awareness indeed plays an important role on fund growth.
According to our result, the high capability of SVI to predict investor attention suggests that the reduction of information asymmetry and enhances the judgment of investors to evaluate whether buy a fund. We also examine the relation between loads and the survival probability of funds.
Consistent to prior researches (Barber et al., 2005), high commission may detrimental to new equity funds since it is the most salient charge compared to other fees. Finally, we confirm that multiple class shares can contribute to asset growth of new funds.
The rest of the paper is organized as follows. The next section reviews the relevant literature and outlines the theoretical and methodological back ground. Section 3 describes data sources and how we construct the SVI for new funds. This section also presents the descriptive statistics of our samples. Section 4 presents the results of our empirical application of survival analysis and OLS regression of cash flow. The final section concludes the paper.
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