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Funds and Liquidity

Paper Session

Friday, Jan. 3, 2025 2:30 PM - 4:30 PM (PST)

San Francisco Marriott Marquis, Yerba Buena Salon 5 & 6
Hosted By: American Finance Association
  • Lubos Pastor, University of Chicago

Information Acquisition by Mutual Fund Investors: Evidence from Stock Trading Suspensions

Clemens Sialm
,
University of Texas-Austin
David Xiaoyu Xu
,
Southern Methodist University

Abstract

We study the impact of liquidity on investors’ information acquisition by examining frequent trading suspensions in China. These suspensions render stocks illiquid, causing significant mispricing of mutual funds because the prices of fund shares are not adequately adjusted for valuation changes of the suspended holdings. We find that the liquidity created by mutual funds’ demandable shares motivates investors to acquire firm-specific information about these illiquid holdings. This acquired information drives flows into underpriced funds and is then incorporated into stock prices when trading resumes. Our findings suggest that liquidity creation by mutual funds increases the amount of information about their illiquid holdings.

Passive Investing and Market Quality

Philipp Höfler
,
Goethe-Universität Frankfurt
Christian Schlag
,
Goethe-Universität Frankfurt
Maik Schmeling
,
Goethe-Universität Frankfurt

Abstract

We show that an increase in passive exchange-traded fund (ETF) ownership leads to stronger and more persistent return reversals in the cross-section of US equities. Removing return components unrelated to liquidity strengthens the effect on short-term reversals, suggesting that passive ETF ownership decreases liquidity. Exploiting exogenous variation from reconstitutions in the Russell indices allows us to further examine the causal impact of passive ETF ownership on stock liquidity as well as other factors of interest. We find that more passive ETF ownership causes higher bid-ask spreads, more exposure to aggregate liquidity shocks, and higher idiosyncratic volatility. We assess whether market participants also price these effects by making use of option-implied tail risk measures, which capture the jump risk in returns. Our findings confirm that stocks with more passive ETF ownership are more prone to extreme price movements in line with recent theoretical work suggesting that passive investments make demand curves for stocks substantially more inelastic. Finally, we examine potential drivers of our results by decomposing a stock’s return variation into different types of information. We show, again using index reconstitutions, that higher passive ETF ownership reduces the importance of firm-specific information, consistent with the view that passive funds crowd out active investors who trade on fundamental information. In addition, passive ETF ownership increases the importance of transitory noise which we attribute to heightened exposure to market-wide sentiment shocks and short-term noise trading.

Active ETFs from Mutual Funds: Competing for Investor Flows

Linda Du
,
Carnegie Mellon University
Laura Starks
,
University of Texas-Austin
Mindy Xiaolan
,
University of Texas-Austin

Abstract

We examine active ETFs, focusing on the recent innovation of less transparent active ETFs, to understand competition in the delegated asset market, particularly between ETFs and mutual funds. We find no cannibalization of mutual fund investor flows from newly cloned ETFs, rather the better reputation of the cloned mutual funds gives the new ETF advantages in attracting flows over their peers, even without better performance. We provide further evidence that investment companies introduce cloned ETFs for flow diversification -- some of the cloned ETF flows are driven by a clientele difference from their mutual fund counterparts.

Discussant(s)
Yao Zeng
,
University of Pennsylvania
Naz Koont
,
Columbia University
Karamfil Todorov
,
Bank for International Settlements
JEL Classifications
  • G1 - General Financial Markets