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Asian Review of Financial Research Vol.23 No.4 pp.437-468
Equity Fund Performance and Cash Flows : Structural Changes, and Start-up and Survivorship Biases
Kwangsoo Ko* Associate Professor, College of Business Administration, Pusan National University
Yeonjeong Ha Ph. D. Candidate, Department of Business Administration, Graduate School of Pusan National University
Key Words : Fund Performance,Cash Flows,Structural Changes,Start-up Bias,Survivorship Bias


The relationship between fund performance and cash flows is very important to fund investors, fund managers, and management companies alike. As is the case in the U. S., many studies have shown that better-performing funds have larger cash flows. This study investigates the relationship between fund performance and cash flows in Korean equity fund markets, and shows the behavior of investors in response to fund performance. Very few studies have considered Korean fund market's unique features. In 2005, the Korean fund markets and industry have faced structural changes that affected the behavior of investors. Based on the structural changes, we show the relationship between fund performance and cash flows. Since 2000, Korea has witnessed great capital influx due to great market expansion. Investors began to be aware of the risk and reward relation of equity funds, and are able to distinguish equity funds from bond funds and bank savings. At the same time, nominal interest rates have drastically declined. As a consequence, the equity fund market has started to attract investors seeking higher returns on their investments. In line with the changing climate of financial markets, the Korean government has allowed commercial banks to conduct fund sales business using their extensive retail networks. As expected, sales businesses by commercial banks have helped accelerate the rapid growth of equity funds. To meet growing investors' demands, investment management companies have devised dollar cost averaging techniques for equity mutual fund investments. They could succeed in launching a host of new equity funds that were designed specifically for dollar cost averaging investments. As a result of these adjustments, by the end of 2004, the demand base of equity funds was further strengthened with much larger market share. Moreover, the assets under management of equity funds following the preponderant dollar cost averaging investments have also begun to grow rapidly, which has provoked structural changes in the Korean mutual fund market. By fully taking into account such unique features and developments in the Korean fund markets, we investigate the relationship between fund performance and cash flows. For this study, fund data are generously provided by Zeroin and FN Guide, Korean financial data providers. The period for empirical analysis runs from January 2001 through December 2007. A total of 223 equity funds are selected among 1,117 public equity funds which have total net assets over 50 billion Korean won on average. One thing that should be noted here is ways in which class funds are handled to make sure to prevent the problems of fund replication. Nowadays, like in the U. S., most funds in Korea are established as class funds which can be included in the same portfolio but with different fee structures. For the purpose of empirical analysis, hence, just a fund should be selected among the same class funds. In this study, in order to prevent the replication bias, only the largest class fund is selected. To investigate the effect of equity fund performance on fund flows, we regress fund flows on equity fund performance and other control variables. According to the previous literature, control variables include standard deviation of past fund returns, past fund flows, market flows, log of total net assets, fund age, and some related dummy variables. Additionally, we employ a switching regression model to reflect the effect of structural changes of fund markets on the relationship between fund performance and flows. The overall results are as follows. First, as expected from the previous U.S. studies, better-performing funds have larger monthly cash flows than the other worse-performing funds. That is to say, investors base their fund investment decisions on the performance. Second, we find that fund performance and cash flows are positively related only for the period of 2005∼2007, based on which we conclude that the structural changes of the fund market affect the performance-flow relationship. Third, we observe the effect of start- up funds caused by enormous cash flows into start-up funds, but it does not affect the conclusion of this study. Also, we do not find any survivorship bias in the Korean fund market. To empirically prove the absence of start-up fund and survivorship biases, we employ both the direct and indirect approaches. Fourth, the best-performing funds in general induce greater cash inflows than do the worst-performing funds. As is the case in the U. S., therefore, we conclude that there exists an asymmetric relationship between fund performance and cash flows for the Korean equity fund markets. We also find evidence supporting the effect of structural changes on the relationship between fund performance and cash flows. Unfortunately in Korea, due to its relatively short history of fund markets and lack of data availability thereof, sufficient studies have not been conducted to fully understand the behavior of fund investors. The increasing number of behavioral finance analyses underlines the importance of understanding the behavior of fund investors for both protecting fund investors and further advancing fund industry. Therefore, we believe that this study could effectively stimulate further research.
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