What Do Fund Flows Reveal About Asset Pricing Models and Investor Sophistication

Recent papers use the relative strength of the relation between fund flows and alphas with respect to various multifactor models to draw inferences about the best asset pricing model and about investor sophistication. This paper analytically shows that such inferences are tenable only under a number of additional assumptions. The results of our simulations and empirical tests indicate that such comparisons are not reliable tests of asset pricing models. We also find that parsimonious factor models better predict future alphas than models with additional factors, and discuss its implications for evaluating investor sophistication.