Leaning for the Tape: Evidence of Gaming Behavior in Equity Mutual Funds

By Mark M. Carhart, Ron Kaniel, David K. Musto, Adam V. Reed. 2002

355 citations recorded by the source corpus.

We present evidence that fund managers inf late quarter-end portfolio prices with last-minute purchases of stocks already held. The magnitude of price inf lation ranges from 0.5 percent per year for large-cap funds to well over 2 percent for small-cap funds. We find that the cross section of inf lation matches the cross section of incentives from the f low0performance relation, that a surge of trading in the quarter’s last minutes coincides with a surge in equity prices, and that the inf lation is greatest for the stocks held by funds with the most incentive to inf late, controlling for the stocks’ size and performance. QUARTER-END AND ESPECIALLY YEAR-END equity mutual fund prices are abnormally high. We present strong evidence that some mutual fund managers mark up their holdings at quarter end through aggressive trading of stocks they already hold. Funds with the greatest ability and most incentive to improve their performance exhibit the largest turn-of-quarter effect. Intradaily data show a surge of transactions and transaction prices in the quarter’s last few minutes, and fund-holdings data show a larger effect in the funds with the most incentive to mark up. Considering that open-end equity funds intermediate $3.46 trillion ~year-end 1999!, 1 this turn-of-quarter inf lation of their prices is a significant opportunity for potential sellers, and a significant hazard for everybody else. In general, open-end domestic equity mutual funds calculate their net asset values per share ~NAVs! from the closing transaction prices of their holdings.

Subfields: Accounting, Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/c1ae417f9e8bad343851ffe0da3e87e3aa11f2b6

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Citations in the corpus

Intraday Patterns in the Cross-Section of Stock Returns (2010, background): “The effect is also not particularly related to the turn-of-the-month effect (Ariel (1987)) or the turn-of-the-quarter effect (Carhart et al. (2002)).”
Do Hedge Fund Managers Misreport Returns? Evidence from the Pooled Distribution (2009, neutral): “As mentioned in Section I, however, Carhart et al. (2002) present evidence that trading in illiquid stocks can temporarily boost returns.”
WSJ Category Kings - the impact of media attention on consumer and mutual fund investment decisions (2017, neutral): “However, Duong and Meschke (2011) show that following circulation of early versions of Carhart et al. (2002), that uncovered the practice, the Security and Exchange Commission enacted enforcement actions against mutual funds participating in this practice, and consequently it has disappeared among…”
Short-Term Persistence in Mutual Fund Performance (2005, background): “To put the magnitude of these results in perspective, note that Carhart et al. (2002) document year-end one-day excess returns that range from 25 basis points for large-cap value funds to 174 basis points for small-cap growth funds.”
Do Hedge Funds Manipulate Stock Prices (2012, positive): “Zweig (1999) and Carhart et al. (2002) find that mutual funds pump the prices of the stocks they hold prior to quarterly reporting dates. Blocher, Engelberg, and Reed (2010) show that short-sellers exercise selling pressure in the last minutes of the year to inflate their returns. Here, we focus on ”
Measuring Closing Price Manipulation (2011, neutral): “Carhart et al. (2002) find that in US equities markets price inflation is localized in the last half hour before the close and that it is more intense on quarter-end days. They attribute this phenomenon to manipulation by fund managers. Similarly, Hillion and Suominen (2004) find on the Paris Bourse”