Effect of fund size on Mutual Fund Performance DISSERTATION

Effect of fund size on Mutual Fund Performance

We investigate the effect of scale on performance in the active money management
industry. We first document that fund returns, both before and after fees and
expenses, decline with lagged fund size, even after accounting for various performance
benchmarks. We then explore a number of potential explanations for this
relationship. This association is most pronounced among funds that have to invest
in small and illiquid stocks, suggesting that these adverse scale effects are related
to liquidity. Controlling for its size, a fund’s return does not deteriorate with the size
of the family that it belongs to, indicating that scale need not be bad for performance
depending on how the fund is organized. Finally, using data on whether funds are
solo-managed or team-managed and the composition of fund investments, we
explore the idea that scale erodes fund performance because of the interaction of
liquidity and organizational diseconomies.

Fund size (net assets under management) affects mutual fund performance. Mutual funds must attain a minimum fund size in order to achieve sufficient returns to justify their costs of acquiring and trading on information. Furthermore, there are diminishing marginal returns to information acquisition and trading, and the marginal returns become negative when the mutual fund exceeds its optimal fund size. In a sample of 683 nonindexed U.S. equity funds over the 1993–95 period, we found that 20 percent of the mutual funds were smaller than the breakeven-cost fund size and 10 percent of the largest funds overinvested in information acquisition and trading. In addition, we found that value funds and blend (value-and-growth) funds have more to gain than growth funds from these information ac…..

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