Do Market Dominant Fund Distributors Provide Better Performing Funds To Investors?

• Author: Young S. Park,Kang Baek
• Published date: 01 June 2015
• DOI: http://doi.org/10.1111/ajfs.12095
• Date: 01 June 2015

Do Market Dominant Fund Distributors

Provide Better Performing Funds To

Investors?*

Kang Baek

Research Division, Korea Small Business Institute

Young S. Park**

Sogang Business School, Sogang University

Received 1 May 2014; Accepted 22 August 2014

Abstract

Uninformed investors preferentially select distribution companies to purchase funds that suit

their investment objectives, as they cannot evaluate each product themselves. Thus, their per-

formance depends significantly on the quality of their fund distributors’ product portfolios.

This study examines whether fund distributors provide better performing funds to investors in

return for distribution fees and, whether market-dominant companies outperform the others.

It differs from previous studies by applying distributor-level as well as fund-level analyses by

calculating the equal- and sales-weighted averages of the funds sold by each distribution com-

pany for all performance measures. The results demonstrate that fund distributors do not gen-

erate positive abnormal returns against the market; moreover, distributors with superior

market power are inferior, except in market timing abilities.

Keywords Distributor-level analysis; Fund distributor; Fund performance; Investor protection; Market

power

JEL Classification: G20, G28, L40

1. Introduction

Research on fund distribution companies

1

can be classified into three categories in

terms of (i) whether fund distributors provide better performing products to investors

*We are grateful to the Korean Securities Association and FnGuide for providing financial

support and research data.

**Corresponding author: Young S. Park, Sogang Business School, 35 Baek beom-ro, Mapo-gu,

Seoul 121-742, Korea. Tel: +82-2-705-8711, Fax: +82-2-715-1589, email: yspark@sogang.ac.kr.

1

Bergstresser et al. (2009) documented that most fund investors hire brokers or advisors to

help them select funds and customize portfolios to their risk tolerances, spending substantial

amounts to compensate these paid distribution channels. They argued that mutual fund bro-

kerages (i) offer higher performing funds, (ii) provide better asset allocation and timing abili-

ties, (iii) identify products that would be hard for the investor to find or evaluate, and (iv)

neutralize investors’ behavioral biases. A 2004 ICI survey of investors found that 88% of bro-

ker channel customers prioritized fund performance.

Asia-Pacific Journal of Financial Studies (2015) 44, 421–446 doi:10.1111/ajfs.12095

©2015 Korean Securities Association 421

(the performance perspective), (ii) whether the distribution fees are proportionate to

the services provided by distribution professionals (the price perspective), and (iii)

which factors determine the cash inflows into fund distributors (the demand perspec-

tive). However, few studies have examined the above questions from the distribution

company’s point of view. Therefore, as a first step, this study measures the perf or-

mance of fund distribution companies at the distributor-level in addition to the fund-

level, and identifies whether they offer an abnormal performance to investors and

whether market-dominant companies outperform the others.

Brokered channels serve as the primary source of product information and

selection criteria in the mutual fund industry (Capon et al., 1996; Alexander et al.,

1998). Bergstresser et al. (2009) reported that brokered distribution is an important

distribution form in the United States, representing 79% (7273 of 9197) of all share

classes, 64% (2712 of 4253) of all funds, and 51% ($2.57 of $5.08 trillion) of all

assets in 2004. Surveys on fund investors in Korea, one of the largest and fastest-

growing emerging fund markets in the world,

2

have also demonstrated that unin-

formed investors, who cannot evaluate each product themselves, preferentiall y select

distribution companies to purchase funds that suit their investment objectives (see

Table 1).

However, fund distribution companies cannot all recommend the same product

portfolios to their investors, because they have varying abilities to evaluate funds,

macro-economic conditions, investment strategies, and preferences. For instance, as

Table 1 Information sources for purchasing funds

Source: Survey on investment confidence index and fund usage, 2012, J. P. Morgan Asset Management

Korea.

Information sources 2011 (%) 2012 (%)

Recommendations of distribution companies 64.3 59.8

Recommendations of surrounding people (e.g., family and friends) 21.1 24.4

Mass communication (e.g., advertising, newspapers) 6.7 8.4

Brochures of asset management companies 4.6 4.9

Internet websites 2.5 2.2

Others 0.8 0.4

2

As of December 2001, $11.7 trillion of world fund assets were held in 55 160 funds, with a

median number of 285 funds per country. The United States, with the largest fund industry

in terms of share of assets held (around 60%), was also the largest in terms of the number of

available mutual funds (8307 funds at the end of 2001). France and South Korea were second

and third, with 7144 and 7117 funds respectively. In terms of growth, from 1996 to 2001, the

ratio of fund industry size to GDP increased by 7.9% on average (median 5.1%). Not all

countries’ fund industries have grown at the same rate, with the slowest growth over this per-

iod being 0.9% (Japan) and the fastest being 26.6% (South Korea; Khorana et al., 2005).

K. Baek and Y. S. Park

422 ©2015 Korean Securities Association