Measures of Downside Risk and Mutual Fund Flows
(Coming Soon)

Abstract: Mutual funds that recently outperformed receive a disproportionate share of new money, despite no clear evidence that good performance persists. In this paper I examine whether consumers also use past performance to identify funds with lower downside risk. I explore the response of fund flows to performance in declining markets compared to the performance in up-markets. Estimates of up and down-market betas as well as down and up-market alphas are obtained from mutual funds' performance conditioned on the sign of the market’s excess returns. Consumers invest more heavily in funds that recently produced higher relative down-market alpha and higher relative up market beta. Fund flows react in a similar way to another proxy of down-market risk based on conditional absolute returns. The results of this research confirm that mutual fund investors seek portfolio insurance, in addition to performance. The tests presented here could be of interest to fund of funds, and are sufficiently general to be explored in other investment products such as hedge funds.