Mapping Mutual Fund Investor Characteristics and Modeling Switching Behavior

Abstract Securing a mutual fund that meets investment goals is an important reason why some investors exclusively stay with a particular mutual fund and others switch funds within their fund family. This paper empirically investigates investor attitudes toward mutual funds. Our model, based on investor responses, develops an investor's "risk profile" variable. Results indicate that regardless of whether the investors invest in nonemployer plans or in both employer and nonemployer plans, they consider their investment risk, fund performance, investment mix, and the capital base of the fund before switching funds. The model developed in this study can also assist in predicting investors' switching behavior. © 2003 Academy of Financial Services. All rights reserved. JEL classification: D12; D31; G23; P34; P46 Keywords: Customer loyalty; Fund switching behavior; Decision models; Risk analysis 1. Introduction Among the many developments in the financial sector, the growth in mutual fund investments is justifiably characterized as one of the most significant. Investments in these funds have increased from $62 billion in 1980 to $3.02 trillion in 2000 (Statistical Abstract, 2001). Mutual funds have become the primary vehicle of investments in capital markets for most individuals and households. It is estimated that nearly 47.4% of American households now own mutual funds, and most of these investors buy professionally managed mutual funds (Priai, 1999). However, evidence indicates that the average mutual fund underperforms a simple market index (Jensen, 1969; Malkiel, 1995). This may be because investors trade and switch funds frequently, which may lower their performance (Carhart, 1997). The various providers of mutual funds are in a heavily competitive market today. Initial estimates show that nearly $55 billion flowed out of equity mutual funds in July 2002 (Mayer, 2002). The primary goal of this paper is to improve our understanding of why investors switch between funds or stay with a particular fund in a family of funds. To understand this behavior, we divide the sample into two groups: investors who own investments exclusively in nonemployer plans versus those who own investments in both nonemployer plans and employer plans [e.g., 401 (k)]. It is hypothesized that investors investing exclusively in nonemployer plans differ on several behavioral dimensions from investors investing both in employer-sponsored and nonemployer plans. This study addresses the distinguishing features of these two types of investors by incorporating the logic functions of an Excel spreadsheet and a statistical model into a hybrid system to identify factors that cause each group of investors to switch funds within a fund family. In addition, as competition between mutual fund companies intensifies and uncertainty regarding the credibility of financial statements increases in the wake of recent accounting scandals, an understanding of investor behavior becomes a critical source of competitive advantage to investment houses. From a funds manager's perspective, it is important to understand why some investors stay with a particular fund and why some switch to other funds within their fund family. This knowledge enables fund managers to accomplish two strategic goals in attracting and retaining new customers. Managers know that retaining customers in a fund family is a less costly and more efficient marketing strategy than finding new customers (Levin, 1993). For this reason, it is strategically important for fund managers to develop customer profiles that will help them answer questions about loyalty and fundswitching behavior of investors. We divide the paper into six sections. In section 2, we review the literature. In section 3, we present the hypotheses and in section 4, we describe the logit model, the intelligent hybrid spreadsheet, and the research method. In section 5, we present the results. …