Impact of Recessions on Equity Mutual Fund Allocations

Sammanfattning: We show that the exposure of US equity mutual funds to Carhart's four-factor model vary with the state of the economy. In bad times, equity mutual funds underinvest in small and value stocks. We find that these reactions can be explained by the change in riskiness of small and value firms. Small firms are more opaque than larger firms and have a harder time coping with the credit crunch that generally follows an economic crisis. Value firms, which derive most of their value from physical capital, suffer more from contractions than growth firms, which in turn obtain the majority of their value from future growth opportunities. Further, we find that there has been a change in allocation to the market proxy between a first time period (1968-88) and a second period (1989-2011). While, during the first period, managers respond to a recession by underinvesting in the market proxy, the contrary happens during the second period. We do not find that the rather large change in the mutual fund industry with a vast increase in index funds can explain this behavior during contractions. Rather, it seems more plausible that the increased financial integration combined with a home bias during times of economic turmoil account for more of the explanation. Ultimately, our results are not completely reliable since the data suffer from a survivorship bias.