Flow-Performance Relationship In The Mutual Fund Industry

In this paper, we explore the flow-performance relationship extensively in the mutual fund industry. Previous studies have shown that the flow-performance relationship is positive and asymmetric. The asymmetric flow-performance relationship provides implicit incentives for fund managers to alter the risk of their portfolios as a function of their mid-year performance. This is known as "Tournament Hypothesis" in the literature. However, recent studies are less supportive of this conjecture.To provide a unified explanation to these seemingly contradictory results, we interpret the flow-performance relationship as an incentive scheme implicitly given to mutual fund managers by mutual fund investors. We explore whether the flow-performance relationship varies over time along business cycle and cross-sectionally with fund attributes. Two methodologies are adopted in our study, namely piecewise linear model and semi-parametric varying-coefficient partially linear model.We show that the flow-performance relationship varies not only with economic activity but also across fund attributes. Our empirical findings provide a fresh perspective on the literature of the flow-performance relationship and give a reasonable explanation to the previous contradictory empirical findings of the tournament hypothesis in the mutual fund industry.