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Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization

  • Joseph Chen
  • Harrison Hong
  • Ming Huang
  • Jeffrey D. Kubik

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.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/0002828043052277
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 94 (2004)
Issue (Month): 5 (December)
Pages: 1276-1302

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Handle: RePEc:aea:aecrev:v:94:y:2004:i:5:p:1276-1302
Note: DOI: 10.1257/0002828043052277
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