Cause and Consequence

• Many investors buy a mutual fund based on its performance. If a fund has been doing well, it attracts new investors and money, and purchases exceed redemption. If a fund's performance has been poor, disappointed investors bail out, swamping the fund with redemption.
  
  

Deteriorating Performance

• A fund must meet a redemption request as soon as it gets it. In a flood of redemption requests, it must sell stocks or bonds from its portfolio right away, regardless of their performance or potential. A fund often sells whatever it can fast, and that could be the best performing stocks because there is sufficient market demand for them. Selling portfolio winners further depresses the fund's results.
  
  

Deeper Hole

• For a losing fund to turn itself around, it must improve performance. This is hard to do when its assets are shrinking from redemption. It must have the money to buy stocks that will go up, but its buys depend on investor inflows and outflows. If investors are redeeming their shares, the fund has less money to work with. It must sell whatever is left after the redemption (often losing, mediocre or illiquid positions) and buy something else, and there is no guarantee that the new purchases will perform any better.
  
  

Management Shakeup

• Mutual fund companies live off mutual fund annual management fees. To grow profits, they must increase assets under management by attracting new customers and new money. They need good performance to market a mutual fund. A fund suffering from poor performance and major redemption is going in the opposite direction and hurting profitability. If a fund's performance does not improve, the company may fire the manager and shut down the fund or merge it into a more successful one.