Investor sophistication : empirical analysis of capital allocation decisions of Norwegian mutual fund investors

Abstract

Whether mutual fund investors act rationally when making capital allocation decision has for long time been one of the key topics in the mutual fund literature. This paper is one of the first attempts to assess investor sophistication in the Norwegian mutual fund market. Using a sample of Norwegian mutual funds in the time period 1996-2018 we find that Norwegian investors do not account for the common risk factors and in fact follow simple signals such as Morningstar ratings when making their investment decisions. We show evidence that Morningstar ratings account only for a very small percentage of funds’ volatility and, thus, investments in highrated funds are unlikely to be motivated by investors’ willingness to outsource risk adjustment to Morningstar. Finally, we show that by investing into high-rated funds investors expose themselves to the risk that they are not compensated for. Our findings suggest that Norwegian mutual fund investors are unlikely to be sophisticated. Keywords: Mutual funds, investor sophistication, Morningstar ratings, fund flows, Norway