How Does Size Affect Mutual Fund Behavior?

Abstract

If actively managed mutual funds suffer from diminishing returns to scale, funds should alter investment behavior as assets under management increase. Although asset growth has little effect on the behavior of the typical fund, we find that large funds and small-cap funds diversify their portfolios in response to growth. Greater diversification, especially for small-cap funds, is associated with better performance. Fund family growth is related to the introduction of new funds that hold different stocks from their existing siblings. Funds with many siblings diversify less rapidly as they grow, suggesting that the fund family may influence a fund's portfolio strategy. Copyright (c) 2008 The American Finance Association.

Overconfidence Among Professional Investors: Evidence from Mutual Fund Managers

“…This is consistent with the aforementioned findings of Pollet and Wilson (2008): funds usually scale up their investments and therefore indirectly impact the turnover ratio by changing the average TNA of the fund in the denominator.…”

“…24 Although the definition of the turnover ratio is already adjusted for the direct impact of inflows (see Section 2.1), there might still be an indirect impact that we can capture by including flows as control variable: Pollet and Wilson (2008) find that fund managers usually use new money inflows to scale up their existing investments. 25 This leads to an increase of the fund's TNA and, ceteris paribus, to a decrease of the turnover ratio (see Section 2.1).…”

“…According to Pollet and Wilson (2008), funds usually respond to new flows by just scaling up their existing investments. Note, that this would not directly influence the fund's turnover ratio per se, because in this case managers just purchase new shares of firms they already hold, but do not sell any securities at the same time.…”

“…Consequently, purchases exceed sales and the nominator of the turnover ratio does not change (see Section 2.1). Pollet and Wilson (2008) use holdings data to show that fund managers only reduce the extent to which they are scaling up existing positions if they face limits to the scalability of their portfolios. Such limits could be a high price impact due to a large portfolio size or high liquidity costs when increasing their ownership share in small-cap stocks.…”

“…9 Second, our paper also relates to the literature on the determinants and consequences of mutual fund manager behavior. Pollet and Wilson (2008) and Coval and Stafford (2007) examine how fund managers react if they face inflows or outflows. The first paper shows that fund managers usually respond to asset growth by simply scaling up their existing investments.…”