Mutual funds biased preference for the parent's stock: evidence and explanation

The potential manager-investor conflict of interests in mutual funds is a classic agency problem. Using a database from Portugal, we show that mutual funds tend to overweight the stocks issued by their parent and underweigh the stocks of competitors. This cannot be explained by performance, risk, securities' characteristics or information advantage; funds invest in the stock of their parent company especially when there is widespread selling, and avoid selling them when the stock is experiencing low performance. This agency relationship is costly for fund investors: compared with the competitor's stock, the parent's stock underperforms after being acquired by the fund.