Effect of sectoral holdings on the flow-performance sensitivity of mutual funds

We find that the flow-performance sensitivity (FPS) of mutual funds depends on the composition of their sectoral holdings. We use the Morningstar classification of fund holdings into the following three Super Sectors: Defensive, Sensitive, and Cyclical. On average, the FPS decreases as the fraction of defensive or sensitive stocks increases in the fund's portfolio. The FPS increases as the fraction of cyclical stocks increases. During high sentiment periods, the sensitivity of new sales as well as redemptions increases, resulting in overall higher FPS for all funds. However, in both the low and the high sentiment periods, the FPS is lower for funds with a higher fraction of defensive or sensitive stocks and higher for funds with a higher fraction of cyclical stocks. Investors with a long investment horizon may wish to avoid mutual funds that invest primarily in cyclical stocks as funds with high FPS tend to have high liquidity costs.

Automated summary

The flow-performance sensitivity (FPS) of mutual funds is affected by the composition of sectoral holdings. An increase in defensive or sensitive stocks decreases FPS, while an increase in cyclical stocks increases FPS. FPS increases during high sentiment periods. However, in both low and high sentiment periods, funds with a higher proportion of defensive or sensitive stocks have lower FPS, while funds with a higher proportion of cyclical stocks have higher FPS. Investors with a long investment horizon should be cautious of mutual funds primarily investing in cyclical stocks due to higher liquidity costs.