The vast majority of financial trades take place in open and highly regulated markets. However, asset managers from mutual fund families sometimes offset their trades with affiliated funds in an internal market. Such cross-trading can allow fund families to shift performance from poorly performing funds to better performing funds, artificially inflating their returns.
Research shows that fund families have incentives to use cross-trades to allocate “extra” performance to popular funds, because outperformers not only attract disproportionate inflows to themselves, but also have positive spillover effects on other funds run by the firm.
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