Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization

51 Pages Posted: 27 Feb 2003 Last revised: 12 Feb 2010

See all articles by Joseph Chen

Joseph Chen

University of California, Davis - Graduate School of Management

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management

Jeffrey D. Kubik

Syracuse University - Department of Economics

Date Written: May 1, 2004

Abstract

We investigate the effect of scale on performance in the active money management industry. We first document that fund returns, both before and after fees and expenses, decline with lagged fund size, even after adjusting these returns by various performance benchmarks. We then explore a number of potential explanations for this relationship. We find that this relationship is most pronounced among funds that have to invest in small and illiquid stocks, which suggests that the adverse effects of scale are related to liquidity. Controlling for its size, a fund's performance actually increases with the asset base of the other funds in the family that the fund belongs to. This suggests that scale need not be bad for fund returns depending on how the fund is organized. Finally, we explore the idea that scale erodes fund performance because of the interaction of liquidity and organizational diseconomies.

Suggested Citation

Chen, Joseph S. and Hong, Harrison G. and Huang, Ming and Kubik, Jeffrey D., Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization (May 1, 2004). American Economic Review, Vol. 94, No. 5, 2004. Available at SSRN: https://ssrn.com/abstract=372721 or http://dx.doi.org/10.2139/ssrn.372721

Joseph S. Chen (Contact Author)

University of California, Davis - Graduate School of Management ( email )

One Shields Avenue
Davis, CA 95616
United States
(530) 752-7155 (Phone)
(530) 752-2924 (Fax)

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ming Huang

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-225-9594 (Phone)

Jeffrey D. Kubik

Syracuse University - Department of Economics ( email )

426 Eggers Hall
Syracuse, NY 13244-1020
United States
315-443-9063 (Phone)
315-443-1081 (Fax)

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