Competition and Conflicts of Interest the U.S. Mutual Fund Industry*

Mutual fund investors desire high risk-adjusted performance at low cost, which may not necessarily be the objective of fund families. Fund families want to maximize assets under management (i.e., their market share) and the resulting management fees. This paper studies the extent to which conflicts of interest are mitigated by competition in the mutual fund industry using the universe of U.S. mutual fund families over the period 1979-1998. During this period, industry assets increased by a factor of twenty, the number of active fund families tripled, and the average market share of a family declined by two thirds. We find that price competition is important in the industry. Families that charge lower fees relative to the competition gain market share, but only if these fees are above average to begin with. Low-cost families do not lose market share by charging higher fees. On the other hand, loads and fees charged explicitly for marketing and distribution (12b-1 fees) have a positive or negligible impact on market share. We find no evidence that investors derive any benefits from these expenses. Product differentiation strategies are also effective in obtaining market share. Families that perform better, and start more funds relative to the competition (a measure of innovation) have a higher market share. Innovation is rewarded more if the new fund is more differentiated from existing offerings and is in a less crowded objective. Finally, market share within an investment objective is driven primarily by a family’s policies within that objective, but there are important performance spillover effects from other funds in the family. Our findings are robust to various tests for endogeneity of the explanatory variables.