Portfolio Pumping in Mutual Fund Families

Abstract

I document portfolio pumping at the fund family level, a strategy that non-star fund managers buy stocks held by star funds in the family to inflate their performance at quarter end. Star funds with high family pumping activities show strong evidence of inflated performance only after 2002, when the Securities and Exchange Commission increased regulation on portfolio pumping at the fund level. Stocks pumped by the strategy show strong reversals at the last trading day of the quarter. Non-star fund managers pumping for star funds receive substantially higher inflows in the future, which cannot be explained by fund characteristics.



Does the increased regulation lead to fewer market manipulations?

Not necessarily. This paper studies how the portfolio pumping strategy evolves when the SEC increased the regulation. Portfolio pumping, also known as leaning for the tape, refers to fund managers buy stocks they have held on the last trading day of the quarter. Such a trading pressure will inflate the fund performance on the quarter-end, following a reversal on the next trading day.

After the publication of Carhart et al. (2002), the SEC started a series of investigation on the portfolio pumping activities. The goal of this paper is to see whether mutual fund managers find loopholes in the regulation and continue to manipulate the market. I show that mutual fund families take a detour and continue to pump their star funds. Specifically, non-star fund managers in the family buy stocks held by their star funds at the quarter-end, which generates a similar trading pressure but is less likely to be detected by the regulator. Non-star fund managers get substantially more inflows in the next quarter, despite of the under-performance due to portfolio distortion. Using advertisement data, I show that pumping managers get more advertising exposures, which can explain the abnormal inflows.

Using CRSP, Thompson Reuters, and Morningstar datasets, I construct the fund-level and family-level pumping measures, where $\textit{Shares Purchased}^{Non-star}_{k,s,t}$ is the number of shares of stock $s$ purchased by non-star fund managers in family $k$ at quarter $t$, normalized by the trading volume of stock $s$, and $w^{Star}_{k,s,t-1}$ is the portfolio weight of stock $s$ of star funds in family $k$ at quarter $t-1$.

The following figures show the performance inflation of star funds before and after 2002, sorted by the Fund Pumping measure.

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Before 2002, the higher the Fund Pumping measure, the greater the performance inflation at the quarter-end and the subsequent reversal at the quarter-beginning. After 2002, when the SEC increased its regulation on portfolio pumping, star fund managers stopped to pump stocks themselves, so that the Fund Pumping measure does not capture the performance inflation anymore.

Instead, non-star fund managers started to buy stocks held by the star funds in the family, which is captured by the Family Pumping measure. The following figure shows the performance inflation for funds sorted by the Family Pumping measure.

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After 2002, the higher the Family Pumping measure, the greater the performance inflation. Note that the sample is exactly the same as the one in the previous figure.