Is the Average Investor Smarter than the Average Euro?

Abstract

In this study, we collect a unique data set of Spanish domestic equity funds for the period 1999–2006 to test the existence of the well-known “smart money” effect. Our focus is to test whether superior performance follows fund flows, demonstrating investor skills, and whether the results are robust for aggregate portfolio analysis and for individual fund analysis. Empirical evidence shows that investor abilities reported by aggregate portfolio analysis are not very evident from a fund-level perspective. This study provides two major contributions to the literature: the separate consideration of purchases and redemptions, and the proposal of a “smart investor” effect which considers investor movements instead of traditional money flows. Results show that investors’ selling decisions are less smart than their buying decisions and that investors, as individuals, are not significantly smarter than money.

Appendix

Table 6 Performance of selling decisions with more flexible taxation (2004–2006). The excess return is calculated as R _it - R _mt , where R _it is the net return of the fund i every month t and R _mt is the return of the benchmark (MSCI Spain). The α ¹ is the average of the individual fund alphas calculated from the time-series regression ${R_{it}} - {R_{ft}} = \alpha_i^1 + \beta_i^1RMR{F_t} + {\varepsilon_{it}}$. The RMRF _ft is the excess return of the market portfolio over the risk-free interest rate, the 1-month Euribor. The α ³ is the average of the individual fund alphas calculated from the time series regression of the three-factor model, ${R_{it}} - {R_{ft}} = \alpha_i^3 + \beta_{iRMRF}^3RMR{F_t} + \beta_{iSMB}^3SM{B_t} + \beta_{iHML}^3HM{L_t} + {\varepsilon_{it}}$, where SMB _t and HML _t are returns on factor-mimicking portfolios for size and value, respectively. Similarly, α ⁴ is the average of the individual fund alphas of the four-factor model that includes the momentum factor. Portfolios are rebalanced monthly, and performance measures are computed for holding periods of 12 months. The numbers in parentheses below performance measures show the p-value for their difference from zero. Flow measures are expressed as a percentage of fund attributes at the beginning of the month. The columns of performance differences between portfolios are calculated following the key in column (a). Numbers in parentheses below these differences show the p-value for the hypothesis that the difference between the two portfolios is zero