Decision-Making under Flow Dynamics: Deconstructing Behavioral Patterns on Portfolio Management

Abstract

This thesis delves into the behavioral patterns of managers within active equity mutual funds, focusing on their trading decisions influenced by various dimensions of return, risk, and capital flows. We pioneer a novel exploration into the scale economies of mutual funds and unravel the complex dynamics of portfolio adjustments in response to significant capital movements. Through our innovative analytical framework, we scrutinize the internal decision-making processes, revealing how managers' perceptions of risks and opportunities critically shape their investment strategies. We introduce a trio of metrics—Risk-Attitude-Purchases (RAP), Risk-Attitude-Sales (RAS), and Risk-Attitude-Trades (RAT)—designed to gauge risk preferences under fluctuating capital conditions, with a particular focus on ESG compliance, illiquidity, and mispricing. The study also contrasts the decision-making and value generation of team versus individually managed funds during periods of capital inflows and outflows, enhancing our understanding of optimal team composition in reaction to flow dynamics. Our empirical findings paint a nuanced landscape of decision-making, where managers transition from information-rich strategic trades to speculative behaviors under heavy inflows, influenced by a non-linear relationship between fund flows and managerial competitiveness across varying skill levels. We document how managers strategically adjust their holdings to balance immediate performance with long-term potential in response to capital movements. Team-managed funds, in particular, demonstrate a significant competitive advantage in managing redemption pressures effectively. These funds excel in making astute trading decisions that preserve and enhance their performance under stress. However, during periods of subscriptions, despite their proven strengths, these teams face challenges in expanding their portfolios and making informed investment choices. Furthermore, we explore the impact of team composition on fund competitiveness, noting that larger, older, and more diverse experienced teams generally perform better. Nevertheless, teams that are vulnerable to social conflicts due to an excess of cultural diversity or interconnectedness might face challenges that could impede portfolio growth.