Ebook Do mutual fund acquisitions affect shareholder wealth: empirical evidence?
An important question in financial economics is why financial intermediaries are so highly compensated, even with the intense competition between them and the uncertainty about whether they add value to investors. Whether active portfolio managers have skill and can obtain persistent positive abnormal returns has been the focus of debate in the mutual fund literature (Chevalier and Ellison, 1997, Carhart, 1997, Wermers, 2000). This has led researchers to question whether there is an opportunity for active mutual fund managers to create compensation for themselves despite the competition from other market participants. Thus far compensation received by managers has been attributed to an irrationally sluggish response by investors to mediocre performance, and the opportunistic exploitation of it by fund managers (Elton, Gruber and Busse, 2004). For instance, in the mutual fund industry investors do not withdraw funds in response to poor past performance to the same extent as they invest in response to superior performance. This asymmetry between inflows and fund performance has been documented in the results of Ippolito (1992), Sirri and Tufano (1992), and Chevalier and Ellison (1997). This evidence raises the possibility that fund complexes making acquisitions decisions may target “undervalued assets”, mutual funds with low objective-adjusted expense ratios, with the intent to increase the expense ratio and, hence, the fees the fund complex can extract from the acquisition target. However, an increase in expense ratios without a corresponding increase in returns of the target fund in the post-acquisition period should lead to a reduction in objective adjusted inflows by rational investors.
Several studies regard mutual fund shareholders as being smart investors (Gruber,1996, Zheng, 1999). For insistence, Barber, Odean, and Zheng (2005) contend that, overtime, investors have become increasingly aware of and averse to mutual fund costs. They find that investors readily avoid high front-end load and commissions costs and tolerate high operating expense costs. This occurs because front-end load fees and commissions are more obvious and salient. Consistent with this, Berk and Green (2004) present an alternative explanation where the ability to extract fees occurs as a natural consequence of learning and compensation goes to managers with investment talents. The implication of this is that if fund complexes acquire “undervalued assets” and subsequently attempt to extract compensation without a corresponding increase in benefits, investors, being smart, will “vote with their feet” by reducing their net flows to these funds in the post-acquisition period.
In their model, Berk and Green present a rational explanation for the lack of persistence in returns and the increasing flow of funds to the mutual fund industry. They postulate that the change in management fees is a function of returns, the precision of these returns and the precision of the market’s prior over managerial ability. This suggests that managerial fees can be collected through the flow of funds. Similarly, GilBazoa and Ruiz-Verdu (2008) develop a model of the market for equity mutual funds that postulates that worse performing funds set fees that are greater or equal to those set by better performing funds, thus allowing fund managers to earn short term equilibrium compensations. By analyzing investment company mutual fund acquisitions, it is possible to empirically investigate the hypotheses advanced by Berk and Green (2004) and Gil-Bazoa and Ruiz-Verdu (2008). Mutual fund acquisitions provide an empirical laboratory where any alteration in fund characteristics and investors responses to these changes can be attributed to the modification in fund management.
This study examines the determinants of fund acquisitions and whether the acquisitions of mutual funds by fund complexes affect the performance of the acquired mutual fund. These determinants can provide insights into investment companies (industry experts) selection criteria for mutual funds. In addition, the acquisitions of investment companies can affect the performance of the acquiring fund family in a couple of ways. First, performance is a direct result of the fund manager’s ability to generate returns for investors and compensation for the investment company. During the acquisition process the acquiring fund families can elect to hire the acquired fund’s incumbent manager or replace the incumbent manager with a new manager, consequently influencing fund performance. Secondly, mutual fund acquisitions can influence the acquiring fund families’ management fees, resulting in an impact on investors’ wealth. Furthermore, Chen, Hong, Huang and Kubik (2004) postulates that a large fund can afford to hire additional managers to cover more stocks, thereby generating additional good ideas, enhancing fund performance.
The benefits from economies of scale should decrease the expense ratio post acquisition. Fund complexes also offer a variety of funds to provide benefits to investors that seek to diversify their holdings or investment objectives as their economic circumstances change. Investors in a given fund within a fund complex can usually exchange their shares for an equal dollar amount of another fund within the same complex. Over the past ten years, fund complexes have acquired mutual funds with or without the incumbent fund manager, in a nonexistent or established fund complex objective. In this study, fund complex acquisitions are examined relative to the acquired fund performance to determine whether mutual fund acquisitions enhance investor wealth.
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