The Determinants of the Convexity in the Flow-Performance Relationship

Abstract

There is substantial evidence that the flow-performance relationship of mutual funds is convex. The authors empirically investigate the determinants of such convexity. In particular, they study how fund fees (for example, marketing and nonmarketing fees) and the uncertainty related to the replacement option of fund production factors (investment strategies and managerial ability) impact the convexity of the flow-performance relationship. The evidence suggests that marketing fees are positively related to the convexity of the flow-performance relationship. Nonmarketing fees appear to have a negative impact on this convexity. Consistent with investment restrictions being relevant in explaining investors’ allocation decisions, sector and index funds exhibit lower convexity in their flow-performance relationship than respectively diversified and non-index funds. Finally, the dispersion of managerial abilities within a mutual fund segment is associated with higher convexity in the flow-performance relationship.