Why Do Mutual Funds Hold Lottery Stocks?

We document large cross-sectional differences in lottery stock holdings among actively managed U.S. equity funds. We examine the incentives and performance of mutual funds that hold more lottery stocks and find that such funds are smaller, younger, and poor recent performers – characteristics typically associated with their desire to attract capital. Poorly performing funds tend to increase their lottery holdings towards the end of year. Funds with more retail clientele and lower managerial ownership hold more lottery stocks. Funds with higher lottery holdings significantly underperform their peers by 4.8% annually. Our findings provide new evidence of funds holding lottery stocks to gather assets by catering to investor preferences and engaging in risk-shifting behavior.