Dressing for style in the mutual fund industry

(with Ryan Bubley)



We define benchmark drift based on changes in a fund's beta relative to its self-promoted benchmark, calculated from the portfolio holdings of both the fund and the benchmark. Benchmark drift has a strong adverse impact on mutual fund flows, even when funds beat the benchmark. Moreover, controlling benchmark drift plays a larger role in portfolio risk management than tournament-style behavior. Both external and internal governance mechanisms work to control benchmark drift: funds with greater institutional investment and those in larger fund families demonstrate less benchmark drift and take stronger steps to reduce it once it occurs.



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