Small Fund Size Matters

Abstract

Mutual fund managers who are assigned to manage multiple mutual funds simultaneously can decide to prioritize certain funds over others. I find that these managers pay the most attention to their smallest fund at the cost of their larger funds, because it is easier to generate higher performance with smaller funds and outperformance is disproportionately rewarded in the mutual fund industry. My empirical analyses show that managers generate 0.35% higher yearly risk-adjusted performance with their smallest fund compared to their other funds. Consistent with preferential attention allocation, this relative outperformance is largely due to the managers taking on more active investment positions, trading more heavily, and leading the institutional crowd more in terms of trades with their smallest fund. I also provide causal evidence for this manager preferential attention allocation by exploiting mutual fund mergers.

Keywords: Mutual Funds, Limited Attention, Utility Maximization, Fund Size

JEL Classification: G11, G23