Scale Diseconomies and Capacity in Fund Management: Variation Across Equity Markets

Abstract

We model the relation between excess returns, fund size and industry size for active equity funds within four markets – global equities, emerging markets, Australia core and Australia small caps – and use the results to investigate the extent to which funds deviate from estimated capacity. We uncover a significantly negative relation between returns and both fund size and industry size across all markets. The estimated percentage of funds operating above versus below capacity varies both across markets and over time, and in the role played by fund size versus industry size. We find greater prevalence of funds operating significantly below than above capacity, in contrast to findings for US equity mutual funds. Significant deviations from estimated capacity persist for a median of between two and six quarters. Our main contribution is to show that the dynamics governing deviations from capacity for active equity funds vary across markets.

Keywords: Equity mutual funds, capacity constraints, economies of scale

JEL Classification: G11, G23, J24