The authors discuss explanations for how and why mutual fund size affects
performance. As fund size grows, performance suffers. As small-cap funds grow,
their performance suffers proportionally more than that of large-cap funds. As
fund family size grows, however, fund performance actually improves. Liquidity
affects small-cap funds about the same as large-cap funds, but large-sized
small-cap funds fare worse than smaller small-cap funds. The organizational
features of a fund's management style affect performance adversely. Rising
bureaucracies and hierarchical decision-making processes (e.g., those of
co-managed funds) suffer compared with those of solo-managed funds.
Many investors perceive that there are certain advantages and disadvantages related to
the size of mutual funds. Common among these perceptions is that larger funds ought to
have lower expenses resulting from economies of scale. Another perception is that
performance suffers as funds increase in size, although fund managers hotly dispute this
contention. The authors not only investigate these notions as other academics have but
also extend the analysis to examine the impact of liquidity and organization.
To investigate fund size and performance, the authors use regression analysis and
cross-sectional analysis and find that the common notions of declining expenses and
returns are mostly true. Their analysis shows that a change in the size of a fund equal
to a two-standard-deviation shock in the log of a fund's total assets yields a decline
of 5.4 to 7.7 bps in monthly performance. This impact is approximately 65–96 bps
annually before fees.
The authors find that the relationship is not significantly affected when considering
small-cap funds, for which trading liquidity is more difficult, but average investors
would expect that small-cap funds would have worse performance. When comparing the
performance of small-cap funds that have larger assets under management (AUM) with those
with smaller assets, they find, however, that large small-cap funds have worse
performance than small ones. Thus, although liquidity does not really matter when
comparing small- and large-sized large-cap funds, it does matter when comparing small-
and large-sized small-cap funds.
To analyze organizational factors, the authors examine fund family size and management
structure. In regard to the size of fund families, they find that the performance for
individual funds improves as the size of the overall fund family grows. Their analysis
shows that for a two-standard-deviation shock to fund family size, an individual fund's
performance rises by 4–6 bps monthly, which is about 48–72 bps annually.
They surmise that efficiencies in trading commissions and higher revenues from stock
lending are responsible. In extending their analysis to compare the performance of
small-cap funds in large or small fund families, the authors find fund family size has
no significant impact. Family size affects large-cap funds but has no effect on
small-cap funds.
The authors' discussion of management structure centers on fund manager compensation.
They seek to answer the question: If fund managers are compensated more for rising AUM
rather than performance, will performance suffer as AUM rise? The authors do not find a
direct link between compensation and AUM, but they do find that the bureaucratic and
hierarchical structures and decision-making process are responsible. In other words, as
AUM grow, it is more likely that funds will be co-managed, resulting in more-expensive
and less-timely decisions. In their study, smaller solo-managed funds perform better
than larger team-managed funds.