TAILIEUCHUNG - Which Money Is Smart? Mutual Fund Buys and Sells of Individual and Institutional Investors

Themore recent research of Sapp and Tiwari (2004), however, argues that the smart money effect documented in prior studies is an artifact of these studies’ failure to account for themomentumfactor in stock returns. Their argument can be synthesized as follows. Stocks that perform well tend to continue doing well (Jegadeesh and Titman (1993)). Investors tend to put their money into ex post best-performing funds. These funds necessarily have disproportionate hold- ings of ex post best-performing stocks. Thus, after buying into winning funds, investors unwittingly benefit from momentum returns on winning stocks. . | THE JOURNAL OF FINANCE VOL. LXIII NO. 1 FEBRUARY 2008 Which Money Is Smart Mutual Fund Buys and Sells of Individual and Institutional Investors ANEEL KESWANI and DAVID STOLIN ABSTRACT Gruber 1996 and Zheng 1999 report that investors channel money toward mutual funds that subsequently perform well. Sapp and Tiwari 2004 find that this smart money effect no longer holds after controlling for stock return momentum. While prior work uses quarterly . data we employ a British data set of monthly fund inf lows and outf lows differentiated between individual and institutional investors. We document a robust smart money effect in the United Kingdom. The effect is caused by buying but not selling decisions of both individuals and institutions. Using monthly data available post-1991 we show that money is comparably smart in the United States. Can investors identify superior mutual funds The first studies to address this question Gruber 1996 Zheng 1999 find that indeed funds that receive greater net money flows subsequently outperform their less popular peers. This pattern was termed the smart money effect. More recent research however finds that after fund performance is adjusted for the momentum factor in stock returns greater net flows no longer lead to better performance Sapp and Tiwari 2004 . In this paper we reexamine the smart money issue with . data. Owing to data constraints all of the above studies work with aggregate money flows to funds All investors are aggregated and sales are offset by repurchases. Furthermore not having access to exact net f lows these papers approximate Keswani is at Cass Business School. Stolin is at Toulouse Business School. Special thanks are due to Robert Stambaugh former editor and an anonymous referee for very helpful comments and suggestions. We are also grateful to Vikas Agarwal Yacine Ait-Sahalia Vladimir Atanasov Rolf Banz Harjoat Bhamra Chris Brooks Keith Cuthbertson Roger Edelen Mara Faccio Miguel Ferreira Gordon Gemmill Matti

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