Which Factors Matter to Investors? Evidence from Mutual Fund Flows. Barber et al (2016)

The authors are trying to find out what is important to investors when they are deciding which mutual funds to invest in.  Ideally, investors should choose the mutual funds with the highest alphas; the problem is that there are many models that calculate alpha using different factors.  For example, the CAPM has market return only; the 3-factor model adds size and value; the 4-factor model adds the momentum factor; and the 7 factor model adds industry factors; and the 9 factor model adds a few more). 

So the authors regress the returns using each of the models onto the mutual fund flows over their period of study; and they chart the alphas for each of the models in the regression.  If investors were adequately assessing the returns of mutual funds, the findings would show that the coefficients on each of the factors is insignificant and the alphas are significant.  What they found is that the CAPM is the best model at explaining the flows into mutual funds; so that would mean that investors likely control for the market return when choosing mutual funds, but they don't adequately control for the other factors when assessing manager skill.

Next, the authors isolate the 7-factor model to assess how each of its factors explain the mutual fund flows.  What they found is that each of the coefficients is statistically significant and positive; so that would mean that investors do not appropriately control for the factor returns when comparing different portfolios and their managers' skill.  The authors also found that the market return factor had the smallest coefficient, which would be in line with the CAPM's alpha being the determinant of choice by investors.

Next the authors considered that maybe more sophisticated investors might control for the factors more adequately than unsophisticated investors.  So they split investors into sophisticated and unsophisticated categories based on the distribution channel of the mutual fund purchase, sentiment of the mutual fund, and wealth level of the investors; then they reran the 7-factor regression to see which factors contributed to the fund flows for each investor category.  As they expected, they found that more sophisticated investors better control for the factors than do unsophisticated investors when making mutual fund purchase decisions.

Barber, B. M., Xing Huang, & Odean, T. (2016). Which Factors Matter to Investors? Evidence from Mutual Fund Flows. Review of Financial Studies, 29(10), 2600–2642.