Marketing Mutual Funds

Abstract

Marketing and distribution expenses are responsible for about a third of the cost of active management in the mutual fund industry. We develop and estimate a structural model of mutual fund marketing with learning about unobserved skill and costly investor search. Our estimates suggest that marketing is nearly as important as performance and fees for determining
fund size. Eliminating marketing substantially improves welfare, as capital shifts towards
cheaper funds and competition decreases fees. Average alpha increases as active funds shrink,
and capital allocation becomes more closely aligned with manager skill net of fees. Declining investor search costs over time imply a reduction in marketing expenses and management fees
as well as a shift towards passive investing, as observed empirically.

Keywords: mutual funds, distribution costs, broker commissions, performance evaluation, capital misallocation, investor welfare, financial regulation, structural estimation, search costs, information frictions, household finance

JEL Classification: G11, G28, D14, M31