Are there relationships between (1) the stock market outlook expressed by a U.S. equity mutual fund manager in semi-annual reports and (2) positioning and performance of that fund? In his October 2019 preliminary paper entitled “Are Professional Investors Prone to Behavioral Biases? Evidence from Mutual Fund Managers”, Mehran Azimi examines these relationships. Specifically, for each such U.S. equity mutual fund semi-annual report, he:
- Uses a word list to identify parts of fund reports that may contain stock market outlooks.
- Applies machine learning to isolate sentences most likely to present outlooks.
- Manually reads and rates these sentences as bearish, neutral or bullish.
- Computes fund manager “Belief” as number of bullish sentences minus number of bearish sentences divided by the total number of sentences isolated. Positive (negative) Belief indicates a net bullish (bearish) outlook.
He then employs regressions to relate fund manager Belief to fund last-year return, asset allocation, portfolio risk and next-year 4-factor (adjusting for market, size, book-to-market and momentum) alpha. Using 40,731 semi-annual reports for U.S. equity mutual funds and associated fund characteristics, holdings and returns during February 2006 through December 2018, he finds that:
- 10,333 of 40,731 (25%) semi-annual reports express stock market outlooks. Of these 10,333:
- 63% (14%) are net bullish (bearish).
- 42% (10%) are unequivocally bullish (bearish).
- Belief relates positively to fund return over the last year. In other words, fund managers with best (worst) last-year performances tend to be the most (least) optimistic.
- Belief relates negatively to fund manager experience with the dot-com crash. In other words, managers who experienced the dot-com crash tend to be more pessimistic than those who did not.
- Belief relates positively (negatively) to fund equity (cash) allocation. In other words, the most optimistic (pessimistic) fund managers tend to have the highest (lowest) equity allocations and the lowest (highest) cash allocations. This effect is strongest among funds with high turnover and low assets under management.
- Belief relates positively to fund stock portfolio beta. In other words, the most optimistic (pessimistic) fund managers tend to hold the riskiest (least risky) stocks. This effect also is strongest among funds with high turnover and low assets under management.
- Belief relates negatively to next-year 4-factor alpha. This effect is strongest among funds with low past fund flows and high expense ratios.
In summary, evidence suggests that mutual fund managers are prone to risk-taking after good last-year performance, to the detriment of their investors.
Cautions regarding findings include:
- The Belief metric is abstract, somewhat personal to the author and not readily available to investors.
- Relationships to Belief are quantified, but do not readily translate to conventional portfolio holdings and future performance metrics.
- Many investors cannot hold enough mutual funds to exploit findings reliably.
