This paper examines the persistence in mutual fund performance which captures the stock selection ability of managers, the smart money effect which captures the fund selection ability of investors and the interaction in Taiwan.
Prior studies of mutual funds generally focus on either the persistence in fund performance or the smart money effect. We examine them at the same time, and further document the interaction between the fund performance and past fund flow. We conduct pairwise nested comparisons of profits from past fund performance and past fund flow. We first sort funds independently into winners and losers by past fund performance (past fund flow), then each of two groups is further subdivided using past fund flow (past fund performance) to form the net zero investment portfolios to examine the performance and smart money effect
Our results can be summarized as follows. First, we use the fund performance and the fund flow to form investment strategies we find these strategies can earn abnormal return. Our results show the persistence in fund performance and the existence of smart money effect. Second, comparing to the strategies only use fund flow or performance to form, the pairwise nested strategies can capture the extra information. Third, extremes of the distribution of the past fund flow are better than past fund performance at predicting future returns. It means investors can learn about fund manager's ability from their past performance to construct the better investments. Finally, the most of winner funds picked out by past fund flow are small size funds, and these winner funds' buy and sell turnover are smaller and ages are older.
