Smart money meets smart size

We examine the smart money effect from two dimensions - fund size and cash flow based on the US open-end equity funds. We find that positive cash flow portfolios earn significant four-factor alphas, and that there exists a quadratic relationship between positive cash flow fund size and abnormal returns. This is a departure from the pure small fund effect documented in the literature. Putting size and cash flows together, we are able to show that conditional on size, funds with higher cash inflows outperform funds with lower cash inflows, and that conditional on cash flows, smaller funds generally outperform larger funds. We conclude that following the money flows into mutual funds can bring higher risk-adjusted returns, especially when the money flows meet the optimal fund size.