A Tale of Bad Days: Investor Preferences and Fund Manager Skill

A Tale of Bad Days: Investor Preferences and Fund Manager Skill

Abstract:
Modern financial markets give investors almost instant access to return data, but whether they react at such high frequency and how this behavior shapes asset managers’ incentives remains unclear. Using novel data on daily mutual fund flows, we show that while investors are insensitive to performance on good market days, their response doubles on bad market days. Bad days also contribute disproportionately to capital reallocation: a single bad day generates as much flow variation as three to five normal days. These flows reallocate capital toward funds that consistently outperform on bad days, which in turn generate about $6.6 million in annual value added for the average fund. Bad-day performance is largely uncorrelated with good-day performance, pointing to distinct bad-day skill. We discuss potential mechanisms for this skill, including specialized trading strategies and broker connections.