Essays in asset management

This thesis contains three essays on the trading behavior and product market innovation of asset managers. The first chapter finds that political beliefs shape professional investors’ interpretations of fiscal policy and, consequently, their asset allocation decisions. Using daily data on Congressional Budget Office cost releases for U.S. legislative proposals, I find that fixed-income mutual fund managers who oppose the current president’s party trade more aggressively and pessimistically in response to news of anticipated rising federal budget deficits. Compared to politically aligned managers, they reduce their positions in long-term Treasury and corporate bonds more significantly while increasing their holdings in Treasury Inflation-Protected Securities. This partisan-driven trading exerts a temporary price impact on Treasury securities and long-term corporate bonds. The second chapter (with Li An, Shiyang Huang, and Dong Lou) documents that despite the removal of all regulatory barriers by 1997, long-short equity mutual funds have seen disappointing growth over the past two decades. We shed new light on this puzzle by documenting a novel set of facts: long-short mutual funds: 1) hold a substantial amount of cash (in excess of cash-collateral requirements) and have an average market beta of 0.6; 2) generate a 5% annual alpha on risky holdings but do not outperform their long-only peers in total returns; and 3) face much higher flow-performance sensitivities and more volatile flows, and use cash buffers more aggressively. These findings challenge prevailing explanations for this puzzle—such as client restrictions, lack of short-selling skills, or high short-selling costs and risks—and motivate a new framework centered on investor clientele and flow responses. The third chapter (with Jiaxing Tian) investigates the decline of traditional mutual funds, focusing on the substitution of mutual funds by collective investment trusts (CITs) in the 401(k) pension investment, and offers insights from both demand and supply sides. Employing several datasets, we demonstrate that CITs are adopted due to their lower fees, comparable returns, and customized nature, aligning with investor preferences sensitive to cost rather than financial transparency. Moreover, mutual fund companies with positive signals, such as past returns and ratings, are incentivized to introduce CITs to reduce auditing costs and gain market shares in 401(k)s. The surge of CITs in 401(k) menus has implications for pension plan governance, with better-governed plans more likely to incorporate CITs. Our findings suggest potential welfare improvements in this delegated asset management model, with investors benefiting from lower total investment costs and mutual fund companies gaining inflow stability. Overall, our research contributes to understanding the dynamics of non-mutual fund investments and their implications for financial markets and investors.