The mutual fund rating puzzle and the impact on investment flows

The rapid growth of assets under management during the second half of the nineties has led the Italian mutual fund industry to the top places of international rankings. In the manager selection, as in other areas of financial intermediation, a central role is played by the amount and the quality of the information available to the investing public. The increasing number of information providers, far from solving the problem of delivering information on the skill of the managers, publish performance measures that not always are useful to address the manager selection problem. The paper aims at analysing the main performance measures in order to show which are the assumptions on which they are built on and which information the investor could expect to obtain from them. Moreover the paper addresses the problem of the peer group construction that is central when the objective of the analysis is to rank the managers according to their efficiency. In the second part of the paper the analysis is shifted on the behaviour of Italian investors in choosing the mutual funds specialised on the Italian equity market. Treating the asset management as an agency relationship the paper is focused on the existence of any direct monitoring by the investor, who, in a competitive market, should be able to incentivate the managers by means of subscriptions and withdrawals. Since the remuneration of the asset manager does, in fact, depend on the total size of the assets under management, the investor has available a reward/punishment mechanism, based on pulling out his money from the worst funds and putting it into the best ones. Empirical evidence shows that there is no direct monitoring mechanism, based on traditional performance indicators. On the contrary, it seems that, there is a strong causal relationship between short term returns, quarterly ones in particular, and the dynamics of the net flows.