Evaluating Fund Capacity: Issues and Methods

Abstract

We examine the issues and methods involved in evaluating the size that a fund might attain before it becomes unable to create additional value for investors. We discuss how capacity is defined; identify ten drivers; and outline methods for conducting capacity analysis. Models that predict capacity assuming a fund adjusts the manner in which it trades or constructs portfolios as funds under management increase are detailed. We also provide an overview of transaction cost modeling, which is integral to predicting capacity. Implications for fund managers, as well as asset owners and other fund investors, are highlighted. This report is primarily written as an aid for investment industry participants who wish to evaluate the capacity associated with a given investment signal.