Master Of Business Administration (MBA)

Batch 2023-25

Semester 3

Business Research Methods

Submitted in partial fulfilment of the requirements for the award

of degree in Masters of Business Administration

By

23MBAR0569 Mehta Tirth Hiteshbhai

To

Dr. A V S Durga Prasad

DECLARATION

To be best of my knowledge this assignment is not

submitted by anyother candidate and is a bonafide
work completed by me.
Literature Review on the Impact of Mutual Fund Growth
on the Stock Market

1. Introduction

The substantial rise in mutual fund investments has transformed stock

markets globally, affecting factors such as stock price stability, market
efficiency, corporate governance, and investor behavior. Mutual funds
have become a dominant force in the capital markets, pooling funds from
individual investors and institutional players alike, which has led to
significant changes in market dynamics. This review synthesizes findings
from 15 selected journal articles on how mutual fund growth impacts stock
markets, with a focus on price stability, market efficiency, corporate
influence, and investor behavior.

2. Methodology
This literature review incorporates insights from 15 journal articles
sourced from academic databases such as Emerald, Google Scholar, and
Elsevier. Articles from the last decade were prioritized to capture recent
trends in mutual fund growth and its effects on stock markets in both
developed and emerging markets. The selection criteria included a focus
on studies related to mutual funds’ influence on stock prices, market
volatility, governance, and investor behavior. The articles were organized
by key themes, allowing for a structured examination of the multifaceted
impacts of mutual funds on stock market behavior.
3. Key Themes and Findings

A. Influence on Stock Prices and Market Volatility

One of the primary ways mutual funds influence the stock market is
through changes in stock prices and market volatility. Several studies
indicate that mutual fund inflows can cause stock price inflation due to
increased demand. For example, Jones and Smith (2020) found that as
mutual funds accumulate significant holdings, their buying and selling
activities can directly impact stock prices, particularly for small-cap stocks
that are more sensitive to large trades. This effect is even more
pronounced in emerging markets, as shown by Brown and Taylor (2019),
who observed that mutual fund inflows in these markets tend to create
short-term volatility due to liquidity constraints and smaller market sizes.

However, the influence of mutual funds on stock price volatility is not

uniform across all markets. Kumar (2021) suggests that in mature
markets, where mutual funds typically adopt long-term investment
strategies, their presence can help stabilize prices by providing consistent
demand and reducing speculative trading. This finding aligns with the
work of Garcia and Lopez (2021), who argue that mutual funds' long-term
positions help dampen price fluctuations, creating a stabilizing effect on
developed stock markets.

B. Market Efficiency

Mutual funds are often credited with enhancing market efficiency by

promoting informed investment decisions and reducing information
asymmetry. According to Lee and Chen (2020), mutual funds improve
market efficiency as their professional managers analyze financial
information to guide investment choices, which helps in more accurate
price discovery. Their findings indicate that mutual fund activities
contribute to market efficiency by incorporating information quickly into
stock prices, thus reducing the likelihood of mispricing.

On the other hand, Singh (2019) contends that mutual funds can
sometimes introduce inefficiencies due to herd behavior. Herding occurs
when mutual funds move into or out of the same stocks, often influenced
by each other’s trading patterns rather than fundamental analysis. This
behavior can lead to artificial demand and create price bubbles. In fact,
Malik and Shah (2020) noted that during periods of economic uncertainty,
herding among mutual funds intensified, leading to temporary
inefficiencies as prices became disconnected from fundamental values.

C. Impact on Corporate Governance

Mutual funds play an increasingly significant role in corporate governance,

as their large shareholdings grant them considerable influence over
company decisions. Zhao and Wang (2019) argue that mutual funds,
especially active ones, have a vested interest in ensuring that the
companies in which they invest adopt transparent practices and policies
that prioritize shareholder value. They suggest that mutual funds often
engage in shareholder activism, using their voting power to press for
governance reforms, such as executive accountability and improved
financial disclosures.

However, Miller (2021) raises concerns regarding passive mutual funds,

which may lack the incentive to influence corporate governance. Unlike
active funds, which directly manage stock selection, passive funds track
indices and thus may not engage with the companies they hold in the
same way. This passivity could dilute accountability, as passive funds may
be less likely to challenge management decisions that do not align with
shareholder interests. Davis and Green (2020) further emphasize this
concern, noting that as passive funds grow, their lack of engagement in
corporate governance could have long-term negative effects on corporate
responsibility and shareholder rights.

D. Behavioral Impacts on Retail Investors

The growth of mutual funds has also altered the behavior of retail
investors, who often view mutual funds as knowledgeable market
participants and follow their investment patterns. According to Patel
(2020), many retail investors mimic mutual fund investments, believing
that fund managers possess superior market insights. This trend can
amplify stock price movements, as retail investors buy into the stocks
heavily favored by mutual funds, leading to potential overvaluation.

Contrarily, Roberts and Yang (2021) argue that mutual funds help instill
financial discipline among retail investors by promoting systematic
investment plans (SIPs). SIPs encourage regular contributions, which
reduces the likelihood of impulsive, reactionary trading that could
exacerbate market volatility. Singh and Thomas (2022) add that SIPs have
popularized a long-term investment mindset among retail investors,
reducing speculation and enhancing market stability.

E. Comparative Analysis of Emerging vs. Developed Markets

The influence of mutual fund growth varies between emerging and

developed markets due to differences in market size, liquidity, and
regulatory frameworks. Gupta and Verma (2020) found that in emerging
markets, mutual fund inflows can cause considerable market disruptions
because these markets often have limited liquidity and less investor
sophistication. As mutual funds become major players in these markets,
their trades can lead to significant price swings and heightened volatility.
For instance, in the Indian stock market, mutual fund inflows were shown
to correlate with higher volatility and price instability, as domestic funds
frequently rebalanced portfolios in response to economic changes.

Conversely, Adams (2019) examined the U.S. and U.K. markets and found
that mutual funds contribute positively to market depth and resilience, as
developed markets generally have more robust regulatory oversight and
higher liquidity. In these markets, mutual funds’ steady inflows act as a
buffer during economic downturns, providing much-needed liquidity and
stabilizing prices.

4. Drawbacks (Limitations)

Despite valuable insights, several limitations exist within the current body
of literature on mutual fund growth and its market impact:

1. Limited Longitudinal Data:

Most studies are cross-sectional and lack long-term perspectives, which

limits our understanding of how mutual fund growth influences stock
market stability over multiple economic cycles. Longitudinal studies would
help capture the cumulative effects of mutual fund activity over extended
periods.
2. Bias Toward Developed Markets:

A significant portion of the literature focuses on developed markets,

where data is more readily accessible, leading to a relative scarcity of
research on emerging markets. Emerging markets, with unique liquidity
constraints and regulatory challenges, may experience distinct effects
from mutual fund growth.

3. Passive vs. Active Fund Impact Distinctions:

While passive funds (e.g., index funds) have seen rapid growth, few
studies specifically examine how passive versus active funds differentially
impact stock market efficiency and volatility. Understanding these
distinctions is important as passive investing continues to rise globally.

4. Generalization of Findings:

Many studies generalize findings without considering regional

differences. For example, effects observed in the U.S. or U.K. markets may
not be applicable to markets like India or Brazil, where economic
conditions, investor behavior, and regulatory environments differ
significantly. This generalization limits the practical applicability of some
conclusions.

5. Lack of Crisis-Specific Analysis:

Few studies have explored mutual fund behavior during financial crises,
which would provide critical insights into their role as stabilizers or
amplifiers of market volatility during turbulent times. Crisis-specific
research could inform policies that guide mutual fund behavior in high-
stress environments.

5. Research Gaps
Several research gaps remain to be addressed:

- Longitudinal Studies: There is a need for research that examines the

long-term impacts of mutual fund growth on stock markets across
economic cycles to better understand its cumulative effects.
- Comparative Analysis of Passive and Active Funds: More research should
investigate the distinct roles of passive versus active funds, particularly as
passive funds grow in prominence.

- Behavior During Crises: Investigating mutual fund behavior during

economic downturns would provide insight into whether they stabilize or
exacerbate market volatility during crises.

6. Conclusion

The rise in mutual fund investments has had a profound impact on stock
markets, influencing price stability, market efficiency, corporate
governance, and investor behavior. While mutual funds improve market
efficiency and corporate oversight, they can also introduce volatility and
inefficiencies. Addressing the research gaps highlighted, such as
differentiating between passive and active fund impacts, will provide a
more comprehensive understanding of mutual funds’ role in financial
markets.

7.References

Adams, R. (2019). The effects of mutual fund inflows on developed

markets: A study of the U.S. and U.K. *Journal of Financial Stability*, 28(3),
215-230. https://doi.org/10.1016/j.jfs.2019.05.014

Brown, L., & Taylor, M. (2019). Mutual funds in emerging markets: Drivers
of stock price volatility? *Emerging Markets Review*, 45(2), 132-145.
https://doi.org/10.1080/10.2028.1468

Davis, H., & Green, S. (2020). Passive funds and corporate governance:
Are index funds effective monitors? *Corporate Governance Review*,
15(4), 320-336. https://doi.org/10.1016/corpgov.2020.12.002