An Explanation for the Momentum Factor
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
This article originally appeared on ETF.COM here.
In a previous article, I discussed the research findings of Itzhak Ben-David, Jiacui Li, Andrea Rossi and Yang Song, authors of the November 2018 study “What Do Mutual Fund Investors Really Care About?” They found that naive retail investor fund flows are driven by Morningstar ratings and raw recent returns (neither of which are adjusted for risk/exposure to common factors found in asset pricing models).
Shiyang Huang, Yang Song and Hong Xiang, authors of the January 2019 study “Fragile Factor Premia,” investigated whether the cash flows of individual mutual fund investors (who are largely ignorant about systematic risks when allocating capital among mutual funds) impact the premium to common factors found in asset pricing models.
They estimated mutual fund flow-induced trading (FIT), which measures the magnitude of flow-driven trading by the aggregate equity mutual fund industry on a particular stock in a given quarter. They use FIT rather than the entire realized trading of mutual funds because FIT captures only those trades driven by the demand shifts from mutual fund investors, which are largely ignorant about fundamentals.