Scale Effects in Mutual Fund Performance: The Role of Trading Costs
41 Pages Posted: 13 Dec 2006 Last revised: 8 Jul 2009
Date Written: March 17, 2007
Berk and Green (2004) argue that investment inflow at high-performing mutual funds eliminates return persistence because fund managers face diminishing returns to scale. Our study examines the role of trading costs as a source of diseconomies of scale for mutual funds. We estimate annual trading costs for a large sample of equity funds and find that they are comparable in magnitude to the expense ratio; that they have higher cross-sectional variation that is related to fund trade size; and that they have an increasingly detrimental impact on performance as the fund's relative trade size increases. Moreover, relative trade size subsumes fund size in regressions of fund returns, which suggests that trading costs are the primary source of diseconomies of scale for funds.
Keywords: Mutual Fund, Trading Costs, Size, Flow, Soft Dollars
JEL Classification: G11, G20, G24
Suggested Citation: Suggested Citation