Financial Product Design and Catering: Evidence from the Global Mutual Fund Industry

What drives delegated portfolio decisions? I provide novel evidence of catering-driven investments by examining a sample of international actively managed equity mutual funds. Mutual funds cater to their investors’ preference for “local” stocks, overweighting stocks headquartered in the client countries, i.e., countries where funds are sold, by 54% to 120% compared to their peers. I refer to this behavior as “client-country overweighting”. Client-country overweighting is stronger in countries where investors display stronger home bias and more pronounced in visible stocks. Client-country overweighting is not driven by the funds’ familiarity bias or by an information advantage. The catering scheme helps funds attract investors, despite delivering underperforming portfolios. Overall, my results suggest that catering is an important driver for mutual funds’ portfolio decisions, and that the catering-driven investment hurts fund performance.