Mutual fund flows, expected returns, and the real economy

This paper investigates the relation between mutual fund flows and the real economy. The findings of this paper support the theory that the positive co-movement of flows into equity funds and stock market returns is explained by a common response to macroeconomic news. Variables that predict the real economy as well as the equity premium - in particular dividend-price ratio, default spread, relative T-Bill rate and consumption-wealth ratio - are related to fund flows and can account for the correlation of flows and market returns. Furthermore, consistent with the information-response hypothesis, mutual fund flows are forward-looking and predict real economic activity.

► I investigate the relation between mutual fund flows and the real economy. ► I find evidence that flows and market returns commonly respond to macroeconomic news. ► Predictive variables are strongly correlated with mutual fund flows. ► Predictive variables can account for the positive correlation between flows and returns. ► Flows, like returns, are forward-looking and predict real economic activity.