Mutual funds bailing out affiliated funds

Two years ago, I blogged about a paper showing that mutual funds support the share prices of their parent banks in Spain. The authors of that paper (Golezyand and Marinz) however argued that Spain is a country “where this type of activities are not closely monitored nor severely prosecuted and punished by the authorities”. In reality, however, this kind of behaviour knows no geographical boundaries.

Pinto and Schmidt study mutual funds in the United States and show that when a mutual fund has difficulty selling illiquid shares in response to redemption pressures, other funds in the same family very conveniently buy the shares and avoid a fire sale. The buying fund (usually a larger and more liquid fund in the same family) suffers a performance loss by absorbing these shares without a sufficiently large price discount.

The takeaway is that if you a buying an illiquid mutual fund, you should buy a fund run by a large mutual fund family to benefit from the liquidity insurance provided by its affiliates. But if you are buying a liquid mutual fund, then you should avoid funds that belong to large families to avoid the performance drag arising out of supporting its affiliates.

Posted at 9:06 pm IST on Mon, 24 Dec 2012         permanent link

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