Mutual fund analyst reports are essential tools for investors. These reports provide valuable insights and information about specific mutual funds, helping individuals make informed investment decisions. During the Inquire Europe autumn seminar in Cologne, Felix Wilke discussed the role of professional fund analysts as information intermediaries within the mutual fund industry in the context of active fund management models. He presented his findings from his research article ‘Mutual Fund Analysts as Information Intermediaries’, in which he explores mutual fund analyst reports and uses dictionary-based and machine learning approaches to measure report tone and examine the extent to which analysts are concerned with fund size.
For those who were unable to attend his presentation, a summary of Felix’ seminar follows:
“Professional mutual fund analysts have an important intermediary role in the active fund management market. According to survey evidence, investment recommendations from advisors are important for investors when they buy into active funds. We have empirical evidence that fund flows follow forward looking analyst ratings; these ratings are from a group of analysts at Morningstar. They publish ratings which capture analysts’ expectations about forward looking fund performance. Importantly, these ratings come with a detailed report in which the analysts explain the ratings decisions. In my paper, I investigate these reports in the context of active fund management models.
These models typically have two key features: First, sophisticated investors learn about and compete for scarce managerial skill. Second, funds are subject to decreasing returns to scale (DRS), any fund given an additional unit of asset under management will have a harder time to outperform its benchmark. However, we have survey evidence that both household and wealthy investors are predominantly not aware of DRS, and we have empirical evidence that professional mutual fund analysts, quantitatively underestimate DRS when they form expectations about fund performance.
In this paper, I therefore examine written analyst reports for worldwide equity mutual funds and I construct two text-based measures: First, the tone of the reports; how negative they are written. Second, a size measure that captures the extent to which fund analysts focus on fund size and capacity in their reports. With these two text based measures, I then investigate the key features of active management models. I’m particularly interested in whether investors exert effort to learn about funds’ manager skills and future prospects, and whether analysts understand and convey the importance of DRS in their reports, as this would allow investors to learn about a fund’s size relative to its capacity when reading the reports.
My three main findings are: 1. Fund flows react to report tone; 2. Report tone also predicts future fund performance; 3. Analysts tend to focus more on fund size and capacity in their reports when funds operate at inefficient sizes. These results are in principle consistent with the key features of active management model: (i) Some investors exert effort to learn about managerial skill from analyst reports; (ii) reports are informative, however, investors reallocate their assets slower than implied by active management models; and (iii) professional analysts qualitatively comprehend the concept of decreasing returns to scale. They are concerned with a fund’s size in light of its capacity, even though analysts quantitatively underestimate the impact of fund size on returns in their performance expectations. Overall, the results suggest that analysts and investors qualitatively understand key model features but quantitatively misjudge them”.
Inquire Europe members can access the research and the presentation slides via: https://www.inquire-europe.org/event/autumn-seminar-2023/