The Effect of Monetary Policies on the Relationship between Advertising and Mutual Fund Flows

• Date: 01 October 2016
• DOI: http://doi.org/10.1111/ajfs.12148
• Author: Wei‐Che Tsai,Ming‐Hung Wu,Miao‐Ling Chen
• Published date: 01 October 2016

The Effect of Monetary Policies on the

Relationship between Advertising and

Mutual Fund Flows

Ming-Hung Wu

Department of Finance, National Sun Yat-sen University

Wei-Che Tsai

Department of Finance, National Sun Yat-sen University

Miao-Ling Chen*

Department of Finance, National Sun Yat-sen University

Received 12 May 2015; Accepted 25 July 2016

Abstract

This paper investigates the effect of monetary policies, mainly proxied by interest rate

changes, on the relationship between advertising and subsequent net cash flows for Taiwan’s

mutual fund industry. Based on a comprehensive mutual fund dataset and allowing for a

precise estimation of fund inflows and outflows, we find that there is a positive advertising–

cash flow relation under different macroeconomic conditions. Taking into account a change

in the interest rate, we document that the positive relationship between the two only exists

when the interest rate is at a relatively low level regardless of restrictive and expansionary

periods. Our empirical findings shed new light on marketing strategies whereby mutual fund

advertising works well during relatively low interest rate environments, which are generally

interpreted as exhibiting low cost of capital and a good signal of future economic

conditions.

Keywords Advertising; Mutual funds; Monetary policy; Panel threshold model

JEL Classification: C32, E43, G11

1. Introduction

As reported in the seminal work of Cronqvist (2006), United States mutual funds

spend about $6 billion per year on advertising, indicating that this channel is an

important marketing strategy for the mutual fund industry. However, prior research

*Corresponding author: Miao-Ling Chen, Professor of Finance, National Sun Yat-sen

University, 70 Lienhai Road, Kaohsiung 80424, Taiwan. Tel: +886-7-525-2000, ext. 4822,

Fax: +886-7-5254898, email: miaoling@mail.nsysu.edu.tw.

Asia-Pacific Journal of Financial Studies (2016) 45, 673–704 doi:10.1111/ajfs.12148

©2016 Korean Securities Association 673

on the impact of advertising on mutual funds’ future cash flows remains inconclu-

sive and contradictory. Some marketing articles demonstrate that advertising cam-

paigns can create intangible assets (e.g., visibility, reputation, and brand awareness)

and increase sales growth, such as Sirri and Tufano (1998), Srivastava et al. (1998),

Huang et al. (2007), Jain and Wu (2000) and Barber et al. (2005).

1,2

On the other

hand, a few studies have shown that the effects of advertising may be limited and

that the impact of advertising on cash flows depends on market states. For instance,

Abraham and Lodish (1990) and Lodish et al. (1995) demonstrate that a significant

number of advertising campaigns generate no relevant increase in sales, whereas

Wood (2009) documents that advertising is likely to only have a short-term sales

impact. Furthermore, Aydogdu and Wellman (2011) suggest that advertising tends

to be ineffective in attracting inflows to funds during a bull market and seems to

work only during bear market conditions.

The nature of macroeconomic cycles (expansion/recession) has been shown to

influence investors’ sentiment and their investment decisions (Baker and Wurgler,

2007; Kurov, 2010; Chung et al., 2012; Stambaugh et al., 2012; Gong et al., 2013).

Garcia (2013) documents the effect of sentiment on asset prices, especially for eco-

nomic recessions, by creating a measure of investor sentiment proxied by the frac-

tion of positive and negative words in financial news, thus providing support for

the notion that investor behaviour may entail different investment decision s as eco-

nomic cycles vary. Bernanke and Kuttner (2005) show that changes in monetary

policy result in changes in the cost of capital and thus have impacts on capital mar-

kets such as stock markets. Furthermore, during periods of economic recession

stock prices likely increase when a central bank cuts interest rates to ease monetary

policy (e.g., Kontonikas et al., 2013).

3

1

Sirri and Tufano (1998) and Huang et al. (2007) discover that advertising can reduce inves-

tors’ search costs, meaning that advertising is positively related to inflows. Jain and Wu

(2000) examine mutual fund advertising in Barron’s and Money magazines to investigate the

relation between advertising and flow. While the studies show no superior performance after

advertising, they reveal that advertisements do attract more money. Barber et al. (2005) show

that funds with higher advertising expenditures on 12B-1 fees garner more new money.

2

Aaker and Keller (1990) and Balachander and Ghose (2003) find that a firm’s advertising for

one of its products not only can increase sales of the advertised product, but also increase

sales of other existing products in the same brand.

3

Kontonikas et al. (2013) find pronounced effects from “cut interest rates” for S&P 500 index

returns in two ways. First, cuts in the federal funds rate (FFR) imply that interest rate easing

is a good signal to stock market participants outside the financial crisis period. State depen-

dence is identified by stocks exhibiting larger increases when interest rate easing coincides

with recessions, bear markets, and tightening credit conditions. Second, an important struc-

tural shift occurred during the recent global financial crisis, changing stocks’ response to FFR

shocks and the nature of state dependence. The unexpected interest rate cuts during the

financial crisis period were not perceived as good news by investors, but rather were inter-

preted as signals of worsening future economic conditions.

M.-H. Wu et al.

674 ©2016 Korean Securities Association

As mentioned before, advertising strategies generally vary with changes in mar-

ket conditions, and investors may then change their investment decisions because

they face macroeconomic uncertainty. This motives us to conduct a test of the fol-

lowing research questions: First, during a period of restrictive monetary policy, do

advertisements convince investors to enter fund markets if the central bank imple-

ments a tightening monetary policy (i.e., an increase in interest rates) to cool down

the overheating the economy? Further, turning to a period of expansionary mone-

tary policy (i.e., a decrease in interest rate), do advertisements attract investors to

enter mutual fund markets?

Second, motivated by the significant effect of macroeconomic conditions on inves-

tors’ investment decisions, our study further extends this line of research to investigate

whether the relative level of interest rates under different macroeconomic cycles,

which signal both the cost of capital and future economic development, influences the

relationship between mutual fund advertising and subsequent net cash flows.

4

In gen-

eral, central bank policymakers cut interest rates to increase the money supply in

order to boost investments and economic growth. Such low interest rate environments

represent a lower cost of capital and encourage investors who have more money to be

willing to take on more investments. As such, more mutual fund advertising may

result in greater cash inflows via attracting investor attention. To the best of our

knowledge, our investigation is the first to study the important role of interest rates

under economic cycles in the advertising–cash flow nexus for mutual funds.

We select an emerging market, Taiwan’s mutual fund market,

5

as our target to

explore the advertising–cash flow relation, because the available dataset can help us

to precisely classify the exact amount of cash inflow and cash outflow for each

mutual fund in each month. In the related literature, scholars usually approximate

mutual fund flows by using the growth of mutual funds’ size. For example, Barber

et al. (2005) measure the quarter-to-qu arter change in total net assets as new

money. In addition to the advantage of having data with exact monthly cash flows,

our empirical approach combines panel threshold modeling (Hansen, 1999) with

time-series techniques of threshold models (Chan, 1993; Hansen, 2000) to capture

the advertising–cash flow relation under different levels of interest rates during

restrictive and expansionary monetary policies. Here, the best advantage of the

threshold model is to demonstrate the asymmetric and non-linear advertising–cash

flow relation with respect to changes in the interest rate.

6

4

Greene and Villanueva (1991) show that the interest rate is negatively related to private

investment, whereas Jorgensen (1963) provides strong theoretical foundations to show the

cost of capital as an important factor for investing.

5

Wei et al. (2011) also utilize a dataset of Taiwan mutual funds to show that advertised funds

in a fund family can significantly increase the cash flows of other higher-performing funds in

the same family.

6

Gertler and Gilchrist (1994) and Kashyap and Stein (2000) present general evidence of asym-

metric effects of monetary policies over the business cycle.

Effect of MP on the AD–cash flow relation

©2016 Korean Securities Association 675