UC Irvine

Motivated by the increasing importance of passive investment, we first compare index funds with actively managed funds and study the trading performance of index funds. Then we explore the implication of mutual fund trading on stock price efficiency. Finally, we investigate the risk disclosure of mutual funds. We document the overlap and differences between actively managed funds and index funds and show that index funds could be active. Index fund trades lose money in general, specifically, stocks bought by index funds on average underperform stocks sold by index funds in subsequent periods. We also find that stocks traded by both actively managed funds and index funds experience efficiency improvement in the subsequent quarter, but in different ways. Stocks traded by actively managed funds exhibit more random walk patterns than those traded by index funds, while trades by index funds improve liquidity and the incorporation of market information. Finally, we show that most disclosed risks by mutual funds in their summary prospectus can be linked to meaningful and well-known academic risk factors. Our findings suggest that disclosed risks in general reflect a large proportion of funds’ investment risks but with substantial cross-fund heterogeneity.