Fund Flows and Performance - A Study of Canadian Equity Funds

We study the behavior of mutual fund investors with a specific focus on fund flows - performance relationship. Using a comprehensive survivorship bias free sample of Canadian open-end equity mutual funds and panel data analysis we find evidence of a rational response of fund flows to upside and downside performance changes. Unlike the findings on US funds and investors, we find that investors neither chase winners nor hang on to losing funds. While investors do allocate funds based on past performance the allocations do not disproportionately in favor star funds. Poor performers experience significant fund withdrawals. Combined with the evidence on a positive association of returns variability with fund flows this fund flow performance relationship shows that the fund incentive structure is not biased towards greater risk taking by fund managers. The size of the fund family and previous fund allocations are also significant in influencing decisions on future fund allocations. We also show lack of short and longterm performance persistence. Inspite of the evidence on a rational response the returns realized by investors are lower than the returns reported by mutual funds suggesting poor ability to time the market.