The structure of open-ended funds discourages fund managers from investing in mis-priced assets and taking longer term risks in funds, a new paper finds.
The research from the University of Oxford finds that the open-ended structure means fund managers are subject to the short-termism of investors and the risk they will pull assets in periods of underperformance.
As a result, fund managers in open-ended funds tend to ignore asset allocations that will take a long time to deliver returns, or mispricing that will take a long time to correct to fundamental values.
University of Oxford associate professor of finance Bige Kahraman says: “An open-end structure, in which investors can react to perceived under-performance by withdrawing capital, leads to short-termism and a persistent overvaluing or undervaluing of assets.”
The research compared open-ended funds with investment trusts and hedge funds, where capital is locked-up for longer. It analysed about 1,500 US-based funds over 20 years.
It found that managers in closed-ended funds took more aggresive positions against mispricing and were willing to buy “fire sale” stocks, which would take a longer period to recover.
“Fund managers who managed both open-end and closed-end funds did not trade against mispricing in the open-end funds even when they were doing so in the closed-end funds, confirming that it is fund structure rather than managerial ability that lies behind the differing investment strategies,” the research states.
Kahraman says: “Open-end structures make it possible for unsophisticated investors to use investment flow to ‘discipline’ fund managers, which means that managers avoid long-term investment strategies that may appear to underperform in the short-term – ironically depriving investors of higher returns overall.”
The research found that manager who run more institutional money, which tends to be stickier and less short-term, were less sensitive to investment outflows and less focused on short-term performance.