Diseconomies of Scale, Information Processing and Hierarchy Costs: Evidence from Asset Management
35 Pages Posted: 18 Mar 2017 Last revised: 20 Apr 2018
Date Written: April 4, 2018
Previous research has suggested that information processing and hierarchy costs play a role in firm-level diseconomies of scale. Using separate accounts (SAs) as a laboratory, we examine if these costs vary across investment style (quantitative vs. fundamental) and what role, if any, they play in producing diseconomies of scale. Consistent with lower hierarchy costs, the average investment professional (e.g., portfolio manager, research analyst, and trader) at a quantitative investment advisor manages two to three times more assets than fundamental advisors. Consistent with greater use of hard information and lower information processing costs, the performance of quantitative SAs exhibit higher factor model R2s, and greater stability in factor betas and tracking error after a change in the management team than fundamental SAs. Moreover, we find higher information diffusion speed in quant SA firms than in fundamental firms, also consistent with lower information processing costs. Finally, controlling for liquidity costs, we find the performance of quantitative SAs is unrelated to size, while fundamental SAs exhibit statistically and economically significant diseconomies of scale. Overall, our results suggest that information processing and hierarchy costs are a source of diseconomies of scale in asset management.
Keywords: Diseconomies of scale, quantitative, fundamental, performance, flows, hierarchy costs, information processing, separate accounts, institutional investing
JEL Classification: G11, G12, L11, L23, L25
Suggested Citation: Suggested Citation