Principles for Drafting an Investment Policy With Illustrations

Common factors in mutual fund flows explain significant fractions of annual and quarterly flows to individual US mutual funds. The factors are persistent and correlated with financial market conditions and macroeconomic variables. We find evidence that the common factors in investor flows are forward looking, although subject to frictions. The systematic components of flows differ substantially across funds according to funds’ ‘flow betas’. High-performing funds’ common factor flows bear an option-like relation to the aggregate sector flows, suggesting a new dimension in the incentives of fund managers. High flow beta funds offer low subsequent returns, consistent with adverse price pressure effects.