Scale and Performance in Active Management are Not Negatively Related
Critical Finance Review, forthcoming
60 Pages Posted: 13 Dec 2018 Last revised: 22 Sep 2021
Date Written: December 4, 2018
We revisit the nature of returns to scale following Pástor, Stambaugh, and Taylor (2015). Using replicated versions of their domestic equity fund sample, we confirm their negative and significant relation between industry scale and performance. However, upon closer examination we find the diseconomies of scale at the industry level result is an artifact of data errors that comprise less than 0.05% of the sample―168 out of 332,516 observations―that occurred most often in the year 2000. We are unable to find industry level diseconomies of scale in the post 2001 era. A major source of these errors is the incorrect use of Morningstar’s current performance benchmarks to measure historical return performance. We confirm the non-result findings using Fama-French three-factor adjusted returns, which are not subject to benchmarking errors.
Keywords: Replication, Returns to scale, Mutual funds, Active management, Passive management, Data errors, Index funds, Influential observations, Outliers, Diseconomies
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation