Advice-Driven Demand and Systematic Price Fluctuations

We show that advice in the form of mutual fund ratings generates correlated demand that creates systematic price fluctuations. Mutual fund investors chase fund performance via Morningstar ratings. Until June 2002, funds pursuing the same investment style had highly correlated ratings. Therefore, rating-chasing investors directed capital into winning styles, generating style-level price pressures that reverted over time. In June 2002, Morningstar reformed its methodology to equalize ratings across styles. Style-level correlated demand via mutual funds immediately became muted, significantly altering the time-series and cross-sectional variation of style returns. Advice-driven demand also explains substantial variation in the size and value factors.