Capital Allocation and the Market for Mutual Funds: Inspecting the Mechanism
42 Pages Posted: 14 Oct 2019
Date Written: October 1, 2019
We analyze the effects of returns to scale on capital allocation decisions in the mutual fund market by exploiting individual heterogeneity in decreasing returns to scale across funds. We find strong evidence that steeper decreasing returns to scale attenuate flow sensitivity to performance and lead to smaller fund sizes. Our results are consistent with a rational model for active management. Using the model, we argue that a large fraction of capital allocation due to differences in decreasing returns to scale can be plausibly attributed to investors anticipating these effects of scale.
Keywords: Capital Allocation, Mutual Funds, Returns to Scale, Fund Flows
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