The causality dilemma

The causality dilemma

Fund managers often face the causality dilemma of, ‘Which came first: attractive returns or assets under management?’ when they launch their first investment vehicle.

It is often thought that attractive returns should lure investors in, but it is important to remember that past performance may not be indicative of future returns.

Nevertheless, fund managers are also aware that an investment vehicle must have a three-year track record and have reached a certain size, usually £100m, to be on an investor’s radar.

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Well, another conventional wisdom is that investors tend to chase performance.

Asset management companies typically promote funds that have achieved top-quartile performance relative to their sector peers over the past three and five years. However, there is no assurance that previous investment conditions will prevail in the future.

Even worse, an increase in the fund size can prevent the investment team from reaching the same level of performance. This begs the question, which did actually come first: attractive returns or AUM?

Testing a theory

I wanted to test the hypothesis that money chases performance. In order to do so, I compared a fund’s change in assets under management relative to its excess return over the past three years.

In other words, has the fund increased in size because of its outstanding performance relative to peers?

My investment universe comprised funds registered by the Investment Association, with the exclusion of sectors which are poorly defined (Specialist and Unclassified). I ran the data between 2015 and 2018, which corresponds to a three-year period.

I split the results into four sections:

• The first section corresponded to funds that have performed poorly, but have attracted inflows.

• The second section corresponded to funds that have performed strongly and have attracted inflows.

• The third section corresponded to funds that have performed poorly and have suffered from outflows.

• The fourth section corresponded to funds that have performed strongly, but have suffered from outflows.

Positive relationship

The results showed that the majority offunds appeared in the second and third sections.

When aggregated, and plotted on a chart, this produced a trend line (despite it having a low significance), proving the hypothesis and indicating a positive relationship between the two variables.

In other words, strong performance does tend to attract money, whereas poor performance results in the bleeding of assets.

It was also reassuring to see that few funds sat in the first section, indicating that a scarce number of funds successfully managed to raise assets despite bad performance.


However, there are a few exceptions to this, which, in my opinion, make the trend less convincing.

First and foremost – the rise of passives. By definition, passive index funds can not generate excess returns since their aim is to behave like the benchmark.

But passive investment vehicles have raised a lot of assets over the past three years due to their cost advantage, and so their performance distorts the trend line.