Conflicting Family Values in Mutual Fund Families

A major reason for the existence of conglomerates or business groups is to create internal capital markets to promote the efficiency of the group. One of many efficiency measures that internal capital markets can offer is an insurance pool, which provides temporary liquidity to the members of the group in the event of adverse shocks.  If mutual fund families, which are a collection of legally independent entities tied together by the sponsoring management company, are regarded as groups, it seems reasonable to assume that there would be a group interest. If so, it seems natural to ask whether insurance pools could exist in these families where cash-rich mutual funds direct capital to family funds that are facing large redemption requests, as these redemptions could lead to large fire sale losses. However, by law, they cannot. This is because, while the provision of such an insurance pool against temporary liquidity shocks benefits the family, the cost is borne by the shareholders of the fund providing this “free” insurance. A mutual fund owes a fiduciary responsibility only to its own shareholders, and not to its family.

In our paper, Conflicting Family Values in Mutual Fund Families, forthcoming in the Journal of Finance, we address whether such insurance pools exist in mutual fund families. We examine this by analyzing the investments of affiliated funds of mutual funds (AFoMFs). AFoMFs are mutual funds that only invest in other mutual funds within the family. Instead of the investors or their financial advisors choosing which mutual funds of the family to invest in, AFoMFs do that for the investors. Virtually non-existent in the 1990s, these funds have become very popular. In 2007, which is the last year of our sample.  Of the 30 large families that made up around 75% of the industry’s assets, 27 had AFoMFs.

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