Does institutional ownership predict mutual fund performance? An examination of undiscovered holdings within 13(f) reports

• Author: Kainan Wang,Blerina Bela Zykaj,Xuhui (Nick) Pan
• DOI: http://doi.org/10.1111/eufm.12209
• Published date: 01 November 2019
• Date: 01 November 2019

DOI: 10.1111/eufm.12209

ORIGINAL ARTICLE

Does institutional ownership predict mutual fund

performance? An examination of undiscovered

holdings within 13(f) reports

Xuhui (Nick) Pan

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Kainan Wang

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Blerina Bela Zykaj

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1

Freeman School of Business, Tulane

University, New Orleans, Louisiana

Email: xpan@tulane.edu

2

College of Business and Innovations,

University of Toledo, Toledo, Ohio

Email: kainan.wang@utoledo.edu

3

College of Business, Clemson

University, Clemson, South Carolina

Email: bzykaj@clemson.edu

Abstract

We show that institutional ownership in equity mutual funds

predicts fund performance. Our measure of institutional

ownership in mutual funds is directly from institutions’

quarterly 13(f) filings so it provides a broader coverage of

institutional investment in mutual funds than existing

studies. Most institutions holding mutual funds are

independent investment advisors and bank trusts who

invest in mutual funds on behalf of their clients. Our results

show that funds held by institutions perform better than

funds not held by institutions for at least 3 years.

Institutions’informational advantage is the main driver of

the outperformance of institution-held funds.

KEYWORDS

13(f) filings, institutional investors, mutual-fund performance, mutual

funds

JEL CLASSIFICATION

G11, G23

We would like to thank the referee Russ Wermers and the editor John Doukas for their helpful comments to improve the

paper. We also thank Elizabeth Berger, Gennaro Bernile, Yong Chen, Susan Christoffersen, Gjergji Cici, Lauren Cohen,

Richard Evans, Ted Fee, Ruslan Goyenko, Jung Hoon Lee, Veronika Pool, Sergei Sarkissian, Christopher Schwarz,

Clemens Sialm, Richard Sias, Yuehua Tang, Harry Turtle, Scott Yonker, Zafer Yuksel, as well as seminar participants at

Clemson University, Miami University, the 2016 Society for Financial Studies (SFS) Finance Cavalcade, the 2015

European Finance Association Meeting, the 2014 Midwest Finance Association Meeting, the 2014 China International

Conference in Finance (CICF), the 2014 Swiss Society for Financial Market Research Conference, and the 2013 Financial

Management Association Meeting.

Eur Financ Manag. 2018;1–37. wileyonlinelibrary.com/journal/eufm © 2019 John Wiley & Sons, Ltd.

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INTRODUCTION

The performanceof actively managed equity mutual funds is extensivelystudied due to its impact on the

US economy. Existing studies identify several fund characteristics as potential determinants of future

fund performance, such as fund size, fund family size, age, fees and expenses, loads, turnover, flows,

volatility, momentum, active share, and R

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There is renewed attention on mutual fund performance

recently, not only becauseindividual investors hold the majority (up to 90%) of totalmutual fund assets,

but also because many companies are pushing their employees toward self-managed retirement plans,

calling for individualinvestors to make their own fund selections.In this paper, we propose a novel fund

characteristic that provides robust predictability of future fund performance beyond other known

predictors documented in the literature: institutional ownership from quarterly 13(f) reports.

Our motivation comes from the widely held notion that institutional investors are collectively more

sophisticated than individual investors. The literature has documented that institutions evaluate, invest

in, and monitor mutual funds more strategically than individual (or retail) investors. Del Guercio and

Tkac (2002) and James and Karceski (2006) argue that institutional investors rely on more

sophisticated performance measures than individual investors. Huang, Wei, and Yan (2012) document

that institutional investors consider additional information, such as volatility and fund track records,

when making investment decisions while individual investors simply use past performance. Evans and

Fahlenbrach (2012) show that institutional investors are more responsive to fund expenses and

performance than individual investors. Goyal and Wahal (2008) and Sialm, Starks, and Zhang (2015)

show that corporate retirement plan sponsors frequently screen the universe of mutual fund investment

options for their employees. This stream of literature yields the hypothesis that institutions can select

good-performing funds and institutional ownership in equity mutual funds from institutions’quarterly

13(f) filings is an ex ante predictor of fund performance.

The extant literature on institutional investment in mutual funds relies on either institutional shares

or affiliated funds. Our study, instead, directly collects institutional holding data from the 13(f) reports.

When thoroughly examining these reports, we find that institutions actively trade, hold, and report

mutual fund shares in 13(f) filings, and the positions are not restricted to institutional class shares or

affiliated funds. During the 2000–2012 sample period, 60% (3,833 out of 6,428) of 13(f) institutions

report holding at least one mutual fund of any kind, and 15% (966 out of 6,428) report holding at least

one domestic actively managed equity mutual fund (the focus of our study). In addition, 39% (1,247 out

of 3,176) of mutual funds in our sample are, at least once, reportedly held by an institution.

Utilizing institutions’13(f) filings, we compare the performance of mutual funds held by

institutions with that of mutual funds not held by institutions over the following quarter, year, and

3 years. We base our results on gross returns instead of net-of-fee returns, to account for the different

fee structures of institutional and retail funds.

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Because our interest is to examine the dynamics of

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See, for example, fund characteristics documented in Grinblatt and Titman (1989), Ippolito (1989), Hendricks, Patel, and

Zeckhauser et al. (1993), Brown and Goetzmann (1995), Malkiel (1995), Gruber (1996), Carhart (1997), Chevalier and

Ellison (1997), Sirri and Tufano (1998), Zheng (1999), Sapp and Tiwari (2004), and Cremers and Petajisto (2009); and

managerial skills documented in Amihud and Goyenko (2013), Kacperczyk, Sialm, and Zheng (2005, 2008), and

Kacperczyk and Seru (2007).

2

Institution-held funds usually charge lower fees than non-institution-held funds. Thus, using net-of-fee returns may

mechanically result in the performance difference between the two groups of funds. Moreover, Berk and Green (2004)

show that the net alpha of mutual funds is determined by the equilibrium competition between investors, not by manager

skills. Nevertheless, to ensure robustness of our findings, in appendix A, section A.2 in the supporting information we show

that our main results stay unchanged when we measure fund performance by net-of-fee returns.

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mutual fund performance in response to institutional ownership, we adopt the conditional alpha

approach of Christopherson, Ferson, and Glassman (1998) to evaluate fund performance. Many papers

advocate the importance of considering macroeconomic conditions in fund performance evaluation

(e.g., Avramov & Wermers, 2006; Banegas, Gillen, Timmermann, & Wermers, 2013) and the

conditional approach allows a fund's alpha and beta to change with the state of the economy.

We document an economically and statistically significant positive relation between institutional

ownership and future mutual fund performance. Analyzing the returns of 3,176 equity mutual funds

from 2000 to 2012, we find that funds held by institutions earn significantly higher future risk-adjusted

returns than funds not held by institutions. Specifically, after controlling for known fund

characteristics, fund styles, and managerial skill proxies, mutual funds held by institutions outperform

those not held by institutions by 0.31% per year (statistically significant at the 5% level) and by 0.92%

over the following 3 years (statistically significant at the 1% level). Furthermore, funds held by

more institutions outperform funds held by fewer institutions (Figure 3). Lastly, the long-term

outperformance is not driven by the short-term performance. The quarterly Carhart alphas of

institution-held funds over the following 3 years are between 0.13% and 0.15%, all statistically

significant at the 5% level or better (Figure 2). By contrast, the alphas for non-institution-held funds

vary from 0.02% to 0.08% and show no statistical significance, except for the following one-quarter

alpha (marginally significant at the 10% level).

The outperformance of institution-held funds is also economically significant. If we were to

redefine our performance measure from returns to dollar value added, the results would be similar

given the significantly larger total net assets of institution-held funds versus non-institution-held funds.

Berk and van Binsbergen (2015) and Pastor, Stambaugh, and Taylor (2015) posit that skilled managers

should be able to extract a larger dollar amount from the financial markets and suggest that the product

of lagged assets under management and gross fund alpha captures this ‘value-added’amount.

Following their methodology, we find that the mean quarterly value added for the portfolio of

institution-held funds is 30 times larger than that of non-institution-held funds, thus supporting the

managerial skill hypothesis of institution-held funds.

To explore the economic source of our findings, we relate the outperformance of mutual funds held

by institutions to institutional investor skills, institutional monitoring, fund flow, and fund flow

volatility. We find evidence supporting the hypothesis that institutions’informational advantage is the

main driver of the outperformance of institution-held funds. Specifically, we find that: (1) fund

performance strengthens with the number of institutions holding the fund; (2) institutions that are good

at picking mutual funds are also good at managing their equity portfolio; (3) institutions that

‘specialize’more in mutual fund investing (e.g., hold more than five equity funds) pick better mutual

funds than other institutions; and (4) institutions that have incentives to select good funds on behalf of

their clients (i.e., independent investment advisors) pick well-performing funds; and (5) the

performance of institution-held mutual funds improves when institutions increase their holdings or

more institutions invest in the fund.

Next, we examine whether the fund outperformance is due to institutional investors’ability to

exercise monitoring. The literature on monitoring has long emphasized that costly monitoring is

deemed possible only when the benefits are sufficiently concentrated to offset the costs. Chen, Harford,

and Li (2007) summarize this research and show that the net benefits of institutional monitoring

increase with the size of the stake, the length of time invested, and the independence of the institution.

Following Chen et al., we identify monitoring institutions in our sample and find the institutional

monitoring effect only in the following quarter. In the longer term, the outperformance of institution-

held funds is entirely due to non-monitoring institutions. Our results concerning the indirect

monitoring such as the twin fund effect (Evans & Fahlenbrach, 2012) are similar in spirit. Evans and

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