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Mutual fund information disclosure: regulatory compliance, signaling, and investor response

How do policy makers help consumers make sound investment decisions?
Regulations which require disclosure of information are among the most popular policy interventions in investor protection. However, there is a paucity of data supporting the efficiency of mandatory information disclosure. In fact, the benefits of disclosure requirements may not be a foregone conclusion: behavioral traits and cognitive limitations on the part of the investors can in some cases even reverse the intended effects of information disclosure. For example, individuals’ information processing abilities have been shown to be limited  such that an increase in mandatory investor information likely leads to an information overload.

With the research project "Mutual fund information disclosure: regulatory compliance, signaling, and investor response", Prof. Dr. Stolper and his team extend the scarce evidence on the utility of investor information disclosure. The project is funded by a 120,000 Euro research grant received from the Fritz Thyssen Stiftung and scheduled to be completed by March 31st 2022. At this, Prof. Dr. Stolper and his team focus on investor information disclosed by actively managed equity mutual funds, since holdings in this asset class represent by far the largest fraction of worldwide retail investments. Also, information disclosure requirements are pervasive for fund companies and the market is a prime candidate for unintended consequences of mandatory disclosure such as information overload: investors face a dizzying number of product options and each product carries a host of characteristics which should be considered in order to make an informed decision.

Investing in an actively managed mutual fund is tantamount to delegating the management of a securities portfolio and we analyze three types of investor information which regulatory authorities have qualified as decision-relevant when it comes to this delegation task. First and foremost, the investor should understand the fund’s key features. The introduction of Key Investor Information Documents (KIIDs) for mutual funds has been the regulator’s response to the quest for a more comprehensible description of the essential product features and we examine if these documents live up to their purpose.

Second, unlike index funds, actively managed funds sell the potential to beat their benchmark (usually a market index) and investors who select this type of mutual fund are typically looking for an opportunity to outperform the market index. Therefore, information about the fund manager’s past commitment in pursuing her goal to beat the benchmark seems highly relevant for investors’ decisions about whom to entrust with the delegated portfolio management. Hence, we analyze how investors use disclosures of a fund’s Active Share (AS), i.e. a measure designed to capture fund managers’ activeness.

Third and finally, fund investors also face ongoing uncertainty about the standard of care which investment professionals exercise when managing their savings and whether they act in their best interest. Specifically, managers of US mutual funds have been required by the regulatory authority to disclose the amount of their private investments in all funds they manage. We analyze how investors respond to such disclosures about managers’ fund ownership and thereby also investigate fund managers’ strategic use of these disclosures to signal aligned incentives to investors.

Prof. Dr. Stolper and his team would like to thank the Fritz Thyssen Foundation for supporting the research project.