Mutual Fund Performance and the Incentive to Generate Alpha




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    • Diane Del Guercio is at the Lundquist College of Business, University of Oregon. Jonathan Reuter is at the Carroll School of Management, Boston College, and is affiliated with the NBER. We are especially grateful to Paula Tkac for helpful discussions and comments. We also thank an anonymous referee, an Associate Editor, John Campbell, Larry Dann, Robin Greenwood, Ro Gutierrez, Campbell Harvey (Editor), Edie Hotchkiss, Greg Kadlec, Abhiroop Mukherjee, Jeff Pontiff, Antoinette Schoar, Phil Strahan, Laurens Swinkels, Hai Tran, Peter Tufano, Eric Zitzewitz, and seminar participants at Harvard University, the 2010 NBER Summer Institute Household Finance Workshop, the 2011 Boston College Center for Asset Management Conference on Financial Markets, and the 2012 HKUST Symposium on Household Finance for helpful comments. Del Guercio would like to acknowledge support from the Finance and Securities Analysis Center at the University of Oregon. We thank Lauren Beaudette and Hai Tran for providing excellent research assistance and Deb Wetherbee at Financial Research Corporation for generously providing data on mutual fund distribution channels.


To rationalize the well-known underperformance of the average actively managed mutual fund, we exploit the fact that retail funds in different market segments compete for different types of investors. Within the segment of funds marketed directly to retail investors, we show that flows chase risk-adjusted returns, and that funds respond by investing more in active management. Importantly, within this direct-sold segment, we find no evidence that actively managed funds underperform index funds. In contrast, we show that actively managed funds sold through brokers face a weaker incentive to generate alpha and significantly underperform index funds.