Informative Fund Size, Managerial Skill and Investor Rationality

Abstract

This paper considers the nature of returns to scale in active management following Pastor, Stambaugh and Taylor (2015) who fail to establish diseconomies of scale at the fund level. Using an enhanced empirical strategy, we find a significant negative impact of fund size on performance. This empirical evidence indicates that fund alpha and fund size are not independent entities. Consequently, skill, rather than being measured by the fund alpha, should be measured by the value that a fund extracts from capital markets. We also show that there is little support for the prevailing belief that as a group, mutual fund investors are naive.

Keywords: Mutual Funds, Managerial Skill, Diseconomies of Scale, Investor Rationality

JEL Classification: G11, G23, J24