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Chasing Winners

Mutual funds focus so much on past returns because investors do. The stakes are very high for the mutual funds because good performance will bring a high degree of new investor cash into the fund, while a poor performance will result in no new investors and the fleeing of some existing investors. Since income to the mutual fund company depends on the amount of assets under management, gaining new money means higher profits for the company and losing investors means lower profits.

Mutual fund investors do appear to chase last year's winners. In a study of 690 mutual funds operating between 1971 and 1990, researchers found that most inflows to mutual funds occurred in the top 20% of the prior year's performance ranking.[12] There was even a great deal of variation in the flow within the top 20% of funds. The highest performing fund could expect over 30% more in new cash invested than the fund ranked at the 80th percentile. Interestingly, the other 80% of the mutual funds could expect relatively little in new investments. The advertising discussed above magnifies the winner chasing behavior. Winner funds that also place ads receive an additional 20% in new investments.


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