The Evidence-Based Investor

Use of Leverage, Short Sales, and Options by Mutual Funds

We study the use of leverage, short sales, and options by equity mutual funds. Consistent with
agency-induced motives for the use of these complex instruments, we find that they are often used
by poorly monitored funds, and are associated with poor outcomes for investors such as lower
performance, higher idiosyncratic risk, more negative skewness, greater kurtosis, and higher fees.
Consistent with moral hazard, we also find that mutual funds that use these instruments hold riskier
equity positions. Mutual funds attempt to use complex instruments to reduce the risk of their
portfolios but in an imperfect and costly way.

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