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

Chen, Joseph; Hong, Harrison; Huang, Ming; Kubik, Jeffrey D.

doi:10.1257/0002828043052277

Cited by 1,198 publications

(758 citation statements)

References 48 publications

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“…Both fund size and lagged flows are negatively and significantly associated with performance, consistent with BG's diseconomies of scale hypothesis. Funds belonging to larger management companies are associated with better performance, as documented by Chen et al (2004). Finally, the fund's back-end load, expense ratio and turnover ratio are negatively related to performance, although the coefficient for turnover ratio is only marginally statistically significant.…”

Section: Fund Visibility and Performance Persistencementioning

confidence: 89%

“…Chen et al (2004) show that, conditional on other fund characteristics, performance decreases with lagged assets under management, especially for funds investing in small-cap growth stocks, suggesting that liquidity is a source of diseconomies of scale portfolio management. Yan et al (2008) confirm these findings using more direct measures of portfolio liquidity.…”

Section: Bg's Influential Work Has Changed the Prevalent View On Mutumentioning

confidence: 93%

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Market Frictions, Investor Sophistication and Persistence In Mutual Fund Performance

Dumitrescu¹,

Gil-Bazo

2012

SSRN Journal

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If there are diseconomies of scale in asset management, any predictability in mutual fund performance will be arbitraged away by rational investors seeking funds with the highest expected performance (Berk and Green, 2004). In contrast, the performance of US equity mutual funds persists through time. In this paper, we report evidence that persistence is less prevalent among hard-to-find funds and investigate whether market frictions can reconcile the assumptions of investor rationality and diseconomies of scale with the empirical evidence. In particular, we extend the setting of Berk and Green (2004) to include entry costs and account for investor heterogeneity in financial sophistication, which we model as differences in reservation returns and the degree of financial constrainedness across investors. We show that for low levels of managerial skill, more visible funds, which are available to a broad set of investors, underperform less visible funds, which are only available to the most sophisticated investors. As managerial skill rises, funds with less sophisticated investors can outperform funds with more sophisticated investors, as a consequence of the interaction of entry costs with financial constraints. Therefore, for a range of managerial skill, hard-to-find funds exhibit less dispersion in equilibrium expected performance. Using data on US equity mutual funds in the 1996-2010 period and different proxies for fund visibility, we find empirical evidence that differences in observed performance are significantly less persistent among hard-to-find funds than otherwise similar funds.JEL codes: G2; G23.

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Section: Fund Visibility and Performance Persistencementioning

confidence: 89%

Section: Bg's Influential Work Has Changed the Prevalent View On Mutumentioning

confidence: 93%

Market Frictions, Investor Sophistication and Persistence In Mutual Fund Performance

Dumitrescu¹,

Gil-Bazo

2012

SSRN Journal

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“…fund returns decrease with fund size and new money-inflows chasing past performance may have a negative impact on future performance. Furthermore, Chen, Hong, Huang and Kubik (2004) confirm that fund size erodes performance due to liquidity and organizational diseconomies, and the relation is more pronounced for funds investing in small and illiquid stocks. We expect that this effect is even stronger for SRI mutual funds, since SRI screens constrain the investment universe.…”

Section: Money-flows and Future Performancementioning

confidence: 54%

Is Ethical Money Financially Smart?

2006

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Little is known about how investors select socially responsible investment (SRI) funds. Investors in SRI funds may care more about social or ethical issues in their investment decisions than about fund performance. This paper studies the money-flows into and out of the SRI funds around the world.We find that ethical money chases past returns. In contrast to conventional funds' investors, SRI investors care less about the funds' riskiness and fees. Funds characterized by shareholder activism and by in-house SRI research attract more stable investors. Membership of a large SRI fund family creates higher flow volatility due to the lower fees to reallocate money within the fund family. SRI funds receiving most of the money-inflows perform worse in the future, which is consistent with theories of decreasing returns to scale in the mutual fund industry. Finally, funds employing a higher number of SRI screens to model their investment universe receive larger money-inflows and perform better in the future than focused funds.Keywords: money-flows, ethical funds, socially responsible investing, persistence in performance, investment screens, corporate governance screens, SRI JEL classification: G10 and G19 2 "Invest with your brain and heart. Invest for our planet… The Funds give investors the ability to unite their financial goals with environmental progress" --from the prospectus of Sierra Club Funds Particular to the socially responsible investment (SRI) funds, often also more narrowly called ethical funds, is that both financial goals and social objectives are pursued. Over the past decade, these SRI funds experienced a tremendous growth in most developed economies around the world. 1 SRI comprises assets under management worth $2.1 trillion, representing approximately 11% of the total assets under professional management in the US (Social Investment Forum, 2003). 2 This paper studies the money-flows into and out of the SRI mutual funds around the world.Some recent studies on the behavior of investors in mutual funds show that both financial and nonfinancial fund attributes affect the choice of a particular mutual fund or hedge fund. Risk-adjusted as well as raw past performance significantly affect the money-flows of mutual funds (see, e.g. , 1997;Goetzmann and Peles, 1997;Sirri and Tufano, 1998;Del Guercio and Tkac, 2002). While the top performing mutual funds attract most of the inflows, the weakly performing funds are hardly affected by outflows. This indicates that once money is invested, it tends to be rather sticky (Gruber, 1996). Furthermore, non-financial attributes like mutual fund visibility (Sirri and Tufano, 1998) In spite of the fact that SRI has become a multi-trillion dollar market, little is known about how investors select funds with explicit non-financial attributes. 3 Investors in SRI mutual funds may 1 The terms SRI funds and ethical funds are often used interchangeably, although strictly speaking ethical funds are a subset of SRI funds. The latter comprise funds whose investment univer...

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“…In unreported results, we find that the significance of this pattern is stronger if one uses the number of holdings to measure fund size. The finding that small funds make superior trades differs from Chen, Hong, Huang, and Kubik (2004), who study the longhorizon returns of large and small funds.…”

Section: B Fund Characteristics and Earnings Announcement Returns Ofmentioning

confidence: 86%

Can Mutual Fund Managers Pick Stocks? Evidence from their Trades Prior to Earnings Announcements

et al. 2005

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We measure the stock-picking skill of mutual fund managers based on the returns realized around the subsequent earnings announcements of the stocks that they hold and trade. Relative to standard methodologies, this approach exploits the most informative segments of the returns data and ameliorates the joint hypothesis problem inherent in tests of stock-picking skill. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. According to our measures of skill, certain funds perform persistently better than others, and the best performers tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers. * We thank Marcin Kacperczyk, Andrew Metrick, Lasse Pedersen, Robert Stambaugh, and seminar participants and New York University and Yale University for helpful comments. We thank Christopher Blake and Russ Wermers for assistance with data. Baker gratefully acknowledges financial support from the Division of Research of the Harvard Business School. Can mutual fund managers pick stocks? Evidence from their trades prior to earnings announcements February 16, 2005 AbstractWe measure the stock-picking skill of mutual fund managers based on the returns realized around the subsequent earnings announcements of the stocks that they hold and trade. Relative to standard methodologies, this approach exploits the most informative segments of the returns data and ameliorates the joint hypothesis problem inherent in tests of stock-picking skill. Consistent with skilled trading, we find that, on average, stocks that funds buy earn significantly higher returns at subsequent earnings announcements than stocks that they sell. According to our measures of skill, certain funds perform persistently better than others, and the best performers tend to have a growth objective, large size, high turnover, and use incentive fees to motivate managers.

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

Cited by 1,198 publications

References 48 publications

Market Frictions, Investor Sophistication and Persistence In Mutual Fund Performance

Market Frictions, Investor Sophistication and Persistence In Mutual Fund Performance

Is Ethical Money Financially Smart?

Can Mutual Fund Managers Pick Stocks? Evidence from their Trades Prior to Earnings Announcements

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