Stock Return Momentum and Investor Fund Choices

Recent research by Gruber (1996) and Zheng (1999) has shown that investors are able to predict mutual fund performance and invest accordingly. This phenomenon has been dubbed the smart money effect. We show that the smart money effect is explained by stock return momentum at the one year horizon. Further analysis suggests that investors do not select funds based on a momentum investing style, but rather simply chase funds with recent large returns. Our finding that a common factor in stock returns explains the smart money effect offers no affirmation of investor fund selection ability