Returns to Scale in Active and Passive Management

53 Pages Posted: 13 Dec 2018 Last revised: 21 Mar 2019

See all articles by John C. Adams

John C. Adams

University of Texas at Arlington

Darren K. Hayunga

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Sattar Mansi

Virginia Polytechnic Institute & State University

Date Written: December 4, 2018

Abstract

We revisit the nature of returns to scale beginning with Pástor, Stambaugh, and Taylor (2015). We find that the documented negative relation between scale (at both the fund and industry levels) and return performance is an artifact of extreme observations that comprise less than 0.05% of the sample. A manual examination against outside sources shows that the origin of these observations are data errors that occurred during the dot-com crash. We then confirm constant returns to scale by revisiting Zhu (2017) where we find outliers driving diseconomies of scale results. We reconcile non-negative returns to scale with Berk and Green (2004) using index funds to proxy for the passively managed component of actively managed funds and find an inverse relation between non-expense-ratio operating costs and fund size. We argue this decline offsets diseconomies of scale in active management.

Keywords: Replication, Returns to scale, Mutual funds, Active management, Passive management, Fake Research, Data errors, Index funds, Influential observations, Outliers, Diseconomies

JEL Classification: G10, G11, G12

Suggested Citation

Adams, John C. and Hayunga, Darren K. and Mansi, Sattar, Returns to Scale in Active and Passive Management (December 4, 2018). Available at SSRN: https://ssrn.com/abstract=3295799 or http://dx.doi.org/10.2139/ssrn.3295799

John C. Adams (Contact Author)

University of Texas at Arlington ( email )

Box 19449 UTA
Arlington, TX 76019
United States
904-476-2946 (Phone)

Darren K. Hayunga

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States
706-542-1365 (Phone)

Sattar Mansi

Virginia Polytechnic Institute & State University ( email )

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