Is Money Smart When Funds are Young?

Researchers have explored whether fund flows can predict future fund performance with mixed results. We investigate the smart money effect in light of a rational agent model built on Berk and Green (2004, Journal of Political Economy, 112). When investors infer the managerial abilities of funds from past fund returns, assuming partial adjustment, the model implies that the smart money effect arises for young funds. Employing a Korean monthly dataset, we establish a smart money effect for young funds but not for the whole fund universe. Further analyses, however, indicate that the smart money effect lasts only one month, and is driven by investment flows responding to public information including past fund returns. The additional findings suggest that an alternative explanation based on non‐managerial characteristics, such as price pressure rather than superior managerial performance, cannot be ruled out yet.