The ABCs of Mutual Funds: A Natural Experiment on Fund Flows and Performance

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Abstract
In the 1990s, a large majority of funds with front-end loads introduced additional share classes, which allowed investors to pay annual fees and/or back-end charges instead of a front-end load. The transition to a multiple-class structure provides a natural experiment with regard to investor clienteles and fund performance. We examine (a) whether the new fee structures increase fund cash flows by attracting investors with different investment horizons and sensitivities to performance; (b) whether changes in the volatility and level of fund flows induced by new investor clienteles affect fund performance - despite little change in fund management and investment objectives. Our finding is that the multiple-class funds, after controlling for performance and fund attributes, attract significantly more new money than the single-class funds. Consistent with the clientele hypothesis, investors in the new classes tend to have a shorter investment horizon and a greater sensitivity to fund performance than investors in the front-end load class. The downside to introducing the new classes, however, is a significant drop in fund performance, which erodes the cash flow benefit of the new classes. Furthermore, the performance drop is shown to be increasing in the relative size of the new classes and in the volatility of their fund flows.