Evidence on Investor Behavior from Aggregate Stock Mutual Fund Flows

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Abstract
Utilizing monthly aggregate flow data for U.S. equity mutual funds over 1986-2008, we document several new findings on investor behavior. First, we find a strong negative relationship between changes in expected market volatility as measured by the VIX index and net equity fund flows. Second, we document several asymmetries in mutual fund investors’ buy-sell decisions. We find that the negative volatility - net flow relationship is entirely due to the effect of volatility on outflows. When volatility increases, equity fund inflows actually increase - just not as much as outflows. In contrast, returns on equity funds only impact inflows, i.e., when returns increase aggregate inflows rise but outflows do not slow. These findings imply that mutual fund investor purchase decisions are primarily driven by returns while redemption decisions are primarily driven by risk perceptions. Suggesting further compartmentalization in investor decision making, we also find an asymmetry in the investor reaction to risk in that both inflows and outflows increase significantly (with a much stronger effect on outflows) as the VIX increases, but there is little effect on either outflows or inflows when the VIX declines. Lastly, we find evidence of month-of-year flow patterns consistent with: 1) tax minimization, and 2) a tendency to reevaluate and rebalance portfolios at the turn-of-the-year.

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