Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization
University of California, Davis - Graduate School of Management
Harrison G. Hong
Princeton University - Department of Economics; National Bureau of Economic Research (NBER)
Cornell University - Samuel Curtis Johnson Graduate School of Management
Jeffrey D. Kubik
Syracuse University - Department of Economics
May 1, 2004
American Economic Review, Vol. 94, No. 5, 2004
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 adjusting these returns by various performance benchmarks. We then explore a number of potential explanations for this relationship. We find that this relationship is most pronounced among funds that have to invest in small and illiquid stocks, which suggests that the adverse effects of scale are related to liquidity. Controlling for its size, a fund's performance actually increases with the asset base of the other funds in the family that the fund belongs to. This suggests that scale need not be bad for fund returns depending on how the fund is organized. Finally, we explore the idea that scale erodes fund performance because of the interaction of liquidity and organizational diseconomies.
Number of Pages in PDF File: 51Accepted Paper Series
Date posted: February 27, 2003 ; Last revised: February 12, 2010
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