Does Fund Size Erode Performance? Liquidity, Organizational Diseconomies and Active Money Management

We investigate the effect of fund size on performance among active mutual funds. We first document that fund returns, both before and after management fees, decline with fund size, even after adjusting performance by various benchmarks and controlling for other fund characteristics such as turnover and age. We then explore a number of potential explanations for this relationship. We find that the effect of fund size on fund returns is most pronounced among funds that play small cap stocks. Interestingly, performance only depends on fund size and does not decline with family size. Finally, small funds are better than large ones at investing in local companies. We argue that these findings are consistent with both liquidity and organizational diseconomies being important factors behind the documented diseconomies of scale in money management. __________________ We are indebted to Jeremy Stein for his many insightful comments. We are also grateful to Paul Pfleiderer, Jack MacDonald, Jonathan Reuter, Jiang Wang, Haicheng Li, Lu Zheng and seminar participants at MIT, Michigan, Illinois, and Stanford for their helpful comments. Hong also thanks the University of Michigan for their hospitality during his visit when the paper was written. Please address inquiries to Harrison Hong at [email protected].