Investors react strongly to how fund companies write their semi-annual shareholder letters: the more negative the tone of a shareholder letter, the lower the fund’s net capital flows. Conversely, the less negative the tone of a letter, the more capital flows in. This is the conclusion of a study by researchers from the Leibniz Institute for Financial Research SAFE and the University of Mannheim, which used text analysis methods to examine the writing style of shareholder letters from 5,489 US equity funds between 2006 and 2021.
“Our analysis shows that the letter’s writing style matters: As negative terms and phrases in a shareholder letter increase, the average fund's net flows decrease by more than three million dollars. Investors react quickly as soon as they receive the document,” says study author Alexander Hillert, Professor of Finance and Data Science at SAFE. This effect varies depending on the age of the fund. “For younger funds, the impact of the shareholder letter’s tone on cash flows is much more pronounced than for older funds,” adds co-author Alexandra Niessen-Ruenzi, Professor of Corporate Governance at the University of Mannheim. The reason is that investors rely more on qualitative information, such as that contained in the writings, for funds with shorter and, therefore, less reliable performance histories.
Nearly half of all US households own mutual funds
In 2021, just under half of all US households (48 percent) owned mutual funds and eventually received shareholder letters. Of the recipients, 63 percent said they read at least part of the message. Mutual funds can use shareholder letters as a tactical tool to influence the flow of capital into the fund. “Investors appreciate honest, realistic reporting with a tone that matches the fund’s performance,” says Hillert. If the tone of a letter contrasts with the actual performance of the fund, net flows are negatively affected.
In another analysis, the researchers show how revealing the tone of letters to shareholders of actively managed mutual funds can be: “A more negative writing style indicates a less daring investment style,” says Niessen-Ruenzi. However, it is impossible to derive a statistically meaningful relationship between the document’s tone and the fund’s future performance.
In the US, letters to shareholders are part of the semiannual reports that investment companies file with the US Securities and Exchange Commission (SEC) and make available to their investors. In these letters, fund managers discuss the general economic environment and outlook, as well as their holdings and performance. The writing style varies widely, from highly technical to almost literary.
Download of SAFE Working Paper No. 380
Scientific Contact
Prof. Dr. Alexander Hillert
Program Director SAFE Data Center
