Risk Shifting and Mutual Fund Performance

Mutual funds change their risk levels significantly over time. Risk shifting might be caused by ill-motivated trades of unskilled or agency-prone fund managers who trade to increase their personal compensation. Alternatively, risk shifting might occur when skilled fund managers trade to take advantage of their stock selection and timing abilities. This article investigates the performance consequences of risk shifting and sheds light on the mecha-nisms and the economic motivations behind risk-shifting behavior. Using a holdings-based measure of risk shifting, we find that funds that increase risk perform worse than funds that keep stable risk levels over time, suggesting that risk shifting either is an indication of inferior ability or is motivated by agency issues. (JEL G11, G23, G32) Mutual funds change their total risk exposure substantially over time. Using the quarterly holdings of a sample of 2,979 U.S. equity funds over the pe-riod between 1980 and 2009, we document that the top and bottom decile of funds on average change their annualized volatility by more than six percent-age points. These changes account for about one-third of the annual realize