Mismarking in Mutual Funds

Abstract

We study mismarking of newly purchased odd lot and two classes of round lot structured product positions in mutual funds. Such mismarking artificially inflates net asset values and overstates cumulative returns. Applied to funds launched after January 2010, a simulation-tested mismarking fund filter identifies 12 Highly Questionable funds managing $75 billion. The performance of these funds matches closely the predicted pattern of mismarking: extremely high alpha and skewness, particularly immediately after launch. We show that structured product mismarking can seriously inflate return-since-inception metrics. We also provide evidence consistent with return smoothing for one quarter of the sample structured product funds. The inflated performance metrics benefit fund managers through significantly higher Sharpe ratios, Morningstar ratings, and asset growth but cause material losses to later investor cohorts. This paper was accepted by Agostino Capponi, finance. Funding: P. Schuster gratefully acknowledges funding by the Deutsche Forschungsgemeinschaft [Grant SCHU 3049/1-1]. Supplemental Material: Data and the online appendices are available at https://doi.org/10.1287/mnsc.2022.4366 .