Fund Size, Transaction Costs and Performance: Size Matters!

32 Pages Posted: 6 Apr 2005 Last revised: 24 Nov 2008

See all articles by H. Chan

H. Chan

University of Melbourne - Department of Finance; Monash University - Department of Accounting

Robert W. Faff

University of Queensland

David R. Gallagher

Capital Markets CRC Limited

Adrian Looi

UNSW Australia Business School, School of Banking and Finance

Date Written: November 20, 2008

Abstract

Recent studies find evidence that small funds outperform large funds. This fund size effect is commonly hypothesized to be caused by transaction costs. Due to the lack of transactions data, prior studies have investigated the transaction costs theory indirectly. Our study, however, analyzes the daily transactions of active Australian equity managers and finds aggregate market impact costs incurred by large managers are significantly greater than that incurred by small managers. Furthermore, we show large managers exhibit preferences for trade package formation and portfolio characteristics consistent with transaction cost intimidation. We analyze the interaction between transaction cost intimidation and the fund size effect, and document that large managers pursuing a highly active trading strategy suffer more from fund size, than large funds following a more passive strategy. This suggests the fund size effect is related to transaction costs, as trading activity is a good proxy for expected market impact. Finally, based on a simulation experiment, we find that transaction cost intimidation is at least as important as the increase in market impact costs due to fund size.

Keywords: Fund size, transaction cost, market impact, fund performance

JEL Classification: G23

Suggested Citation

Chan, Howard and Faff, Robert W. and Gallagher, David R. and Looi, Adrian, Fund Size, Transaction Costs and Performance: Size Matters! (November 20, 2008). Available at SSRN: https://ssrn.com/abstract=697581 or http://dx.doi.org/10.2139/ssrn.697581

Howard Chan

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

Monash University - Department of Accounting ( email )

Building 11E
Clayton, Victoria 3800
Australia

Robert W. Faff

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

David R. Gallagher

Capital Markets CRC Limited ( email )

GPO Box 970
55 Harrington Street
Sydney, NSW 2001
Australia

Adrian Looi (Contact Author)

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

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