Investor Clientele and Style Changing Behavior in Mutual Funds

This paper examines different clienteles’ reactions to style changing behavior of mutual funds. Using the granularity of daily mutual fund data, we show that heterogeneity in investors’ sophistication levels strongly relates to heterogeneity in responses to style changing behavior. The empirical approach that we apply to several proxies of investors’ sophistication level indicates that less sophisticated investors reward style-changing behavior by an increase in fund flow, while more sophisticated investors punish this behavior by redemption. We show that style changing behavior has different impact on various types of fund performance measures. More specifically, style deviation has a strong positive impact on the simple fund performance measures, which are used by less-sophisticated investors, while it has no significant impact on more advanced fund performance measures. Our empirical findings also report that less-sophisticated investors drive the aggregate investors’ reactions to the style deviation. Overall, we argue that a comparison of the fund flow-style changing relationship, by accounting for investor’s sophistication level, allows for a more complete picture of an investor’s response to the changes in mutual funds’ investment style behavior.