What Drives Mutual Fund Asset Concentration?

33 Pages Posted: 24 Jul 2008 Last revised: 3 May 2010

See all articles by Yonathan Schwarzkopf

Yonathan Schwarzkopf

Lime Brokerage LLC; Santa Fe Institute

J. Doyne Farmer

University of Oxford - Institute for New Economic Thinking at the Oxford Martin School; Santa Fe Institute

Date Written: March 16, 2010

Abstract

Is the large influence that mutual funds assert on the U.S. financial system spread across many funds, or is it is concentrated in only a few? We argue that the dominant economic factor that determines this is market efficiency, which dictates that fund performance is size independent and fund growth is essentially random. The random process is characterized by entry, exit and growth. We present a new time-dependent solution for the standard equations used in the industrial organization literature and show that relaxation to the steady-state solution is extremely slow. Thus, even if these processes were stationary (which they are not), the steady-state solution, which is a very heavy-tailed power law, is not relevant. The distribution is instead well-approximated by a less heavy-tailed log-normal.

We perform an empirical analysis of the growth of mutual funds, propose a new, more accurate size-dependent model, and show that it makes a good prediction of the empirically observed size distribution. While mutual funds are in many respects like other firms, market efficiency introduces effects that make their growth process distinctly different. Our work shows that a simple model based on market efficiency provides a good explanation of the concentration of assets, suggesting that other effects, such as transaction costs or the behavioral aspects of investor choice, play a smaller role.

Keywords: mutual fund growth, firm growth, investor behavior, mutual fund flows, size distribution, power law

Suggested Citation

Schwarzkopf, Yonathan and Farmer, J. Doyne, What Drives Mutual Fund Asset Concentration? (March 16, 2010). Available at SSRN: https://ssrn.com/abstract=1173046 or http://dx.doi.org/10.2139/ssrn.1173046

Yonathan Schwarzkopf (Contact Author)

Lime Brokerage LLC ( email )

625 Broadway
New York, NY 10012
United States

Santa Fe Institute

1399 Hyde Park Road
Santa Fe, NM 87501
United States

J. Doyne Farmer

University of Oxford - Institute for New Economic Thinking at the Oxford Martin School ( email )

Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

HOME PAGE: http://www.inet.ox.ac.uk/people/view/4

Santa Fe Institute ( email )

1399 Hyde Park Road
Santa Fe, NM 87501
United States
505-984-8800 (Phone)
505-982-0565 (Fax)

HOME PAGE: http://www.santafe.edu/~jdf/

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