DO RETAIL MUTUAL FUND INVESTMENTS REPRESENT “DUMB MONEY”?

This paper studies the behaviour of Indian retail mutual fund investors to determine if they (a) chase performance - get timing of buys and sells wrong, (b) use fund selection and market timing criteria different from international and domestic financial institutions and, (c) lose out in performance, thereby exhibiting a “dumb money” effect. The study uses panel data fixed effects regression analysis of cash flows of 209 open-ended equity funds across 16 top AMCs from 2014–2017. Using monthly average assets under management data at fund, scheme, investor and distribution channel levels, the study fills the gap in current research that fails to address fund-level investor specific issues, or consider the impact of distribution channels such as brokers/agents. The study finds that retail investor cash flows and contemporaneous market returns are strongly negatively correlated in a time-varying fashion with investors reacting to market movements instead of staying invested. Median flows into high performance funds are twice that into poor performing funds, indicating the presence of a flow-performance convexity relationship popularly cited in literature. Flows are 1.6 times more likely into low expense ratio funds; retail investors prefer less risky funds. Institutional investor trading behaviours are distinctly different from retail, with foreign institutional investors (FIIs) focusing on poor-performing funds, while banks are strong momentum-style traders. Retail investors lose 0.22% to 0.79% on raw returns compared to a “buy and hold” strategy which translates to up to 1.3% less returns than foreign and domestic institutional investors. These results are robust to fund size, distribution channels, expense ratios, fund fixed effects, events such as demonetisation, time periods, flow types and fund performance measures. Instead of relying on professional fund management and treating mutual funds as long-term investments, retail investors trade actively, exhibiting poor fund selection and timing skills, resulting in dumb money flows.