Investor flows and the assessed performance of open-end mutual funds

Open-end equity funds provide a diversified equity positions with little di rect cost to investors for liquidity. This study documents a statistically significant indirect cost in the form of a negative relation between a fund 's abnormal return and investor flows. Controlling for this indirect cost o f liquidity changes the average fund's abnormal return (net of expenses) fr om a statistically significant - 1.6% per year to a statistically insignifi cant - 0.2% and also fully explains the negative market-timing performance found in this and other studies of mutual fund returns. Thus, the common fi nding of negative return performance at open-end mutual funds is attributab le to the costs of liquidity-motivated trading. (C) 1999 Elsevier Science S .A. All rights reserved.