Does Stock Return Momentum Explain the “Smart Money” Effect?




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    • Travis Sapp is at Iowa State University, and Ashish Tiwari is at the Tippie College of Business at the University of Iowa. We are grateful to Rick Green (the editor) and an anonymous referee for their insightful comments and suggestions. We also thank Tom George, Puneet Handa, Gary Koppenhaver, Mike Stutzer, Anand Vijh, and Lu Zheng for their helpful feedback. Any errors are our own.


Does the “smart money” effect documented by Gruber (1996) and Zheng (1999) reflect fund selection ability of mutual fund investors? We examine the finding that investors are able to predict mutual fund performance and invest accordingly. We show that the smart money effect is explained by the stock return momentum phenomenon documented by Jegadeesh and Titman (1993). Further evidence suggests investors do not select funds based on a momentum investing style, but rather simply chase funds that were recent winners. Our finding that a common factor in stock returns explains the smart money effect offers no affirmation of investor fund selection ability.