The Mismatch between Mutual Fund Scale and Skill
60 Pages Posted: 9 Nov 2017
Date Written: August 1, 2017
I demonstrate that skill and scale are mismatched among actively managed equity mutual funds. Many mutual fund investors behave as though they rely on the Capital Asset Pricing Model. They confuse the effects of fund exposures to other common factors with managerial skill. Actively managed mutual funds with positive factor-related past returns thus accumulate assets to the point that they significantly underperform. I also show that the negative aggregate benchmark-adjusted performance of all actively managed equity mutual funds is caused mainly by the poor performance of this small subset of oversized funds. My model predicts that less skilled active fund managers tilt their portfolios toward common factors in order to gather more flows and collect more fees. I find empirical evidence consistent with the model's predictions.
Keywords: Mutual fund, Skill, Scale
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