To begin, the authors studied the role of media coverage in investors’ capital allocations to mutual funds. A 2000 survey by the SEC found that more than 40 percent of investors rely heavily on the information derived from mass media when choosing their mutual fund investments. The following is a summary of their findings:
Media coverage of mutual fund holdings has a significant effect on investors’ capital allocation decisions.
Investors’ capital flows respond to holdings’ past returns, but only if these holdings were covered in widely circulated newspapers in the preceding quarter.
Investors allocate significantly more (or less) capital to mutual funds holding media-covered stocks with high (or low) past returns. If a fund holds shares in a high-profile failure, such as Enron, it will face greater outflows than an identical fund holding a stock with a similarly low return but without newspaper coverage. In fact, the returns of holdings that weren’t covered in major newspapers in the trailing quarter don’t impact future mutual fund flows.
The effect on flows is driven more by rewarding mutual funds that hold media-covered winners than penalizing funds that hold media-covered losers.
Fund flows react to holdings’ returns strongly in the periods after disclosure, but not before. The effect of media-covered holdings on mutual fund flows is driven by the disclosure of those holdings.
Investors’ reaction to media-covered holdings is driven by media coverage of stocks rather than media coverage of mutual funds.
Comparing returns to risk-adjusted benchmarks, there’s no evidence that investors receive higher returns by investing in mutual funds with media-covered past winners while likely incurring substantial transaction costs from fund chasing.
What the Study Found
The authors concluded that media coverage does influence investor behavior. However, it does so in a way that exacerbates behavioral biases, such as that of chasing recent mutual fund performance. It seems that mutual funds intent on growing inflows have been correct to engage in a well-documented, but misleading, activity known as “window dressing.” Window dressing occurs when mutual funds buy recent winners just before a reporting date because they believe investors will assume that the fund was skillful in identifying the past winners ex-ante. And as we’ve seen, investors tend to chase media darlings. Unfortunately, the evidence shows that this behavior only helps the profits of fund companies, not the returns of investors.
Reacting to news from the financial media is among the many mistakes investors tend to make. My book, Investment Mistakes Even Smart Investors Make and How to Avoid Them, covers 77 such errors. Moreover, by the time you have heard or read about any information in the media, it’s almost certain that whatever value it may contain has already been embedded in prices. Thus, whether it’s news about the latest CPI or GNP, earnings reports or the holdings of a certain mutual fund, you’re best served by ignoring it.
The Bottom Line
Reacting to the news isn’t likely to improve gross returns, but it is likely to lead to lower net returns due to increased transaction costs and taxes.
Larry Swedroe is director of research for The BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.
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