Three essays on funds of mutual funds

Although funds of mutual funds (FoMFs) constitute a significant segment in the mutual fund industry, virtually no empirical research has been conducted. Moreover, the existing literature focuses on aggregate investor flows, which leaves the flow decisions of different investor groups in veil. By using FoMFs, I examine the behavior of a specific group of professional investors over time; furthermore, this examination provides the first in-depth insights about this emerging sector of the mutual fund industry. The first essay examines FoMFs as a competing structure to advisory services. First, the flow-performance relationship associated with FoMFs' buys and sells suggests that affiliated FoMFs instill a competitive environment in the family by increasing inflows to good performing funds and withdrawing investments from poorly performing funds. These affiliated FoMFs, who are "insiders" within the fund complex, also tend to buy/sell the right funds and therefore display a superior fund selection skill. However, unaffiliated FoMFs show no sensitivity to performance nor do they display fund selection ability. Overall, professional oversight of fund operations and superior selection of constituent funds are the value-additions that FoMFs provide for the investors. The second essay examines the complexities of internal capital markets in mutual fund families by using a hand-collected dataset of affiliated funds of mutual funds, which are mutual funds that only invest in funds in their own family. Preliminary results document that AFoMFs offset severe liquidity shortfalls of other funds in their fund complex. This action reduces AFoMF performance but benefits the funds that receive such liquidity because it allows them to avoid fire sales. From my third essay, for a sample of 690 FoMFs started between 1993 and 2007, I find that FoMFs initiations are positively related to the FoMFs' prior performance and the decision by large families to open similar funds in the prior year. Furthermore, consistent with the presence of scale and scope economies, I find that the total number of family funds is significantly associated with FoMFs opening decisions. Lastly, I find that the rise of pension plans has an influence on the growth of the funds of mutual funds industry as well as additional fee income generation.