IDEAS home Printed from https://ideas.repec.org/a/aea/aecrev/v94y2004i5p1276-1302.html
   My bibliography  Save this article

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

Author

Listed:
  • Joseph Chen
  • Harrison Hong
  • Ming Huang
  • Jeffrey D. Kubik

Abstract

We investigate the effect of scale on performance in the active money management industry. We first document that fund returns, both before and after fees and expenses, decline with lagged fund size, even after accounting for various performance benchmarks. We then explore a number of potential explanations for this relationship. This association is most pronounced among funds that have to invest in small and illiquid stocks, suggesting that these adverse scale effects are related to liquidity. Controlling for its size, a fund's return does not deteriorate with the size of the family that it belongs to, indicating that scale need not be bad for performance depending on how the fund is organized. Finally, using data on whether funds are solo-managed or team-managed and the composition of fund investments, we explore the idea that scale erodes fund performance because of the interaction of liquidity and organizational diseconomies.

Suggested Citation

  • Joseph Chen & Harrison Hong & Ming Huang & Jeffrey D. Kubik, 2004. "Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization," American Economic Review, American Economic Association, vol. 94(5), pages 1276-1302, December.
    • Handle: RePEc:aea:aecrev:v:94:y:2004:i:5:p:1276-1302
    Note: DOI: 10.1257/0002828043052277
    as

    Download full text from publisher

    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/0002828043052277
    Download Restriction: no
    File URL: http://www.aeaweb.org/aer/data/dec04_data_hong.zip
    Download Restriction: Access to full text is restricted to AEA members and institutional subscribers.
    ---><---

    References listed on IDEAS

    as
    1. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    2. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
    3. Harrison Hong & Terence Lim & Jeremy C. Stein, 2000. "Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies," Journal of Finance, American Finance Association, vol. 55(1), pages 265-295, February.
    4. Harrison Hong & Jeffrey D. Kubik & Amit Solomon, 2000. "Security Analysts' Career Concerns and Herding of Earnings Forecasts," RAND Journal of Economics, The RAND Corporation, vol. 31(1), pages 121-144, Spring.
    5. Berger, Allen N. & Miller, Nathan H. & Petersen, Mitchell A. & Rajan, Raghuram G. & Stein, Jeremy C., 2005. "Does function follow organizational form? Evidence from the lending practices of large and small banks," Journal of Financial Economics, Elsevier, vol. 76(2), pages 237-269, May.
    6. Aghion, Philippe & Tirole, Jean, 1997. "Formal and Real Authority in Organizations," Journal of Political Economy, University of Chicago Press, vol. 105(1), pages 1-29, February.
    7. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
    8. Daniel, Kent, et al, 1997. "Measuring Mutual Fund Performance with Characteristic-Based Benchmarks," Journal of Finance, American Finance Association, vol. 52(3), pages 1035-1058, July.
    9. Judith Chevalier & Glenn Ellison, 1999. "Career Concerns of Mutual Fund Managers," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(2), pages 389-432.
    10. Jonathan B. Berk & Richard C. Green, 2004. "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1269-1295, December.
    11. Patrick Bolton & David S. Scharfstein, 1998. "Corporate Finance, the Theory of the Firm, and Organizations," Journal of Economic Perspectives, American Economic Association, vol. 12(4), pages 95-114, Fall.
    12. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    13. George P. Baker & Thomas N. Hubbard, 2000. "Contractibility and Asset Ownership: On-Board Computers and Governance in U.S. Trucking," NBER Working Papers 7634, National Bureau of Economic Research, Inc.
    14. Bengt Holmstrom & John Roberts, 1998. "The Boundaries of the Firm Revisited," Journal of Economic Perspectives, American Economic Association, vol. 12(4), pages 73-94, Fall.
    15. Paul A. Gompers & Andrew Metrick, 2001. "Institutional Investors and Equity Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(1), pages 229-259.
    16. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    17. Brown, Keith C & Harlow, W V & Starks, Laura T, 1996. "Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 51(1), pages 85-110, March.
    18. Joshua D. Coval & Tobias J. Moskowitz, 2001. "The Geography of Investment: Informed Trading and Asset Prices," Journal of Political Economy, University of Chicago Press, vol. 109(4), pages 811-841, August.
    19. Grinblatt, Mark & Titman, Sheridan D, 1989. "Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings," The Journal of Business, University of Chicago Press, vol. 62(3), pages 393-416, July.
    20. Edwin J. Elton & Martin J. Gruber & Christopher R. Blake, 2001. "A First Look at the Accuracy of the CRSP Mutual Fund Database and a Comparison of the CRSP and Morningstar Mutual Fund Databases," Journal of Finance, American Finance Association, vol. 56(6), pages 2415-2430, December.
    21. Falkenstein, Eric G, 1996. "Preferences for Stock Characteristics as Revealed by Mutual Fund Portfolio Holdings," Journal of Finance, American Finance Association, vol. 51(1), pages 111-135, March.
    22. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    23. Almazan, Andres & Brown, Keith C. & Carlson, Murray & Chapman, David A., 2004. "Why constrain your mutual fund manager?," Journal of Financial Economics, Elsevier, vol. 73(2), pages 289-321, August.
    24. Grinblatt, Mark & Titman, Sheridan & Wermers, Russ, 1995. "Momentum Investment Strategies, Portfolio Performance, and Herding: A Study of Mutual Fund Behavior," American Economic Review, American Economic Association, vol. 85(5), pages 1088-1105, December.
    25. Chen, Joseph & Hong, Harrison & Stein, Jeremy C., 2002. "Breadth of ownership and stock returns," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 171-205.
    26. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lan, Chunhua & Moneta, Fabio & Wermers, Russ, 2018. "Holding Horizon: A New Measure of Active Investment Management," CFR Working Papers 15-06, University of Cologne, Centre for Financial Research (CFR), revised 2018.
    2. Edelen, Roger M. & Ince, Ozgur S. & Kadlec, Gregory B., 2016. "Institutional investors and stock return anomalies," Journal of Financial Economics, Elsevier, vol. 119(3), pages 472-488.
    3. Cohen, Randolph B. & Gompers, Paul A. & Vuolteenaho, Tuomo, 2002. "Who underreacts to cash-flow news? evidence from trading between individuals and institutions," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 409-462.
    4. Hung, Pi-Hsia & Lien, Donald & Kuo, Ming-Sin, 2020. "Window dressing in equity mutual funds," The Quarterly Review of Economics and Finance, Elsevier, vol. 78(C), pages 338-354.
    5. Hao Jiang & Marno Verbeek & Yu Wang, 2014. "Information Content When Mutual Funds Deviate from Benchmarks," Management Science, INFORMS, vol. 60(8), pages 2038-2053, August.
    6. Agarwal, Vikas & Gay, Gerald D. & Ling, Leng, 2012. "Performance inconsistency in mutual funds: An investigation of window-dressing behavior," CFR Working Papers 11-07 [rev.], University of Cologne, Centre for Financial Research (CFR).
    7. Lewellen, Jonathan, 2011. "Institutional investors and the limits of arbitrage," Journal of Financial Economics, Elsevier, vol. 102(1), pages 62-80, October.
    8. Jiang, Hao & Sun, Zheng, 2014. "Dispersion in beliefs among active mutual funds and the cross-section of stock returns," Journal of Financial Economics, Elsevier, vol. 114(2), pages 341-365.
    9. Casavecchia, Lorenzo, 2016. "Fund managers' herding and the sensitivity of fund flows to past performance," International Review of Financial Analysis, Elsevier, vol. 47(C), pages 205-221.
    10. Kelsey D. Wei & Russ Wermers & Tong Yao, 2015. "Uncommon Value: The Characteristics and Investment Performance of Contrarian Funds," Management Science, INFORMS, vol. 61(10), pages 2394-2414, October.
    11. Amil Dasgupta & Andrea Prat & Michela Verardo, 2011. "Institutional Trade Persistence and Long‐Term Equity Returns," Journal of Finance, American Finance Association, vol. 66(2), pages 635-653, April.
    12. Daniel, Kent & Hirshleifer, David & Teoh, Siew Hong, 2002. "Investor psychology in capital markets: evidence and policy implications," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 139-209, January.
    13. Agarwal, Vikas & Boyson, Nicole M. & Naik, Narayan Y., 2007. "Hedge funds for retail investors? An examination of hedged mutual funds," CFR Working Papers 07-04, University of Cologne, Centre for Financial Research (CFR).
    14. Mikhail Simutin, 2014. "Cash Holdings and Mutual Fund Performance," Review of Finance, European Finance Association, vol. 18(4), pages 1425-1464.
    15. Marcin Kacperczyk & Clemens Sialm & Lu Zheng, 2005. "On the Industry Concentration of Actively Managed Equity Mutual Funds," Journal of Finance, American Finance Association, vol. 60(4), pages 1983-2011, August.
    16. Agarwal, Vikas & Gay, Gerald D. & Ling, Leng, 2014. "Window dressing in mutual funds," CFR Working Papers 11-07 [rev.3], University of Cologne, Centre for Financial Research (CFR).
    17. Hao Jiang & Michela Verardo, "undated". "Does herding behavior reveal skill? An analysis of mutual fund performance," FMG Discussion Papers dp720, Financial Markets Group.
    18. Michael J. Brennan & Xiaolong Cheng & Feifei Li, 2012. "Agency and Institutional Investment," European Financial Management, European Financial Management Association, vol. 18(1), pages 1-27, January.
    19. Agarwal, Vikas & Gay, Gerald D. & Ling, Leng, 2013. "Window dressing in mutual funds," CFR Working Papers 11-07 [rev.2], University of Cologne, Centre for Financial Research (CFR).
    20. Marcin Kacperczyk & Clemens Sialm & Lu Zheng, 2008. "Unobserved Actions of Mutual Funds," The Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2379-2416, November.

    More about this item

    Lists

    This item is featured on the following reading lists, Wikipedia, or ReplicationWiki pages:
    1. Does Fund Size Erode Mutual Fund Performance? The Role of Liquidity and Organization (AER 2004) in ReplicationWiki

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:aea:aecrev:v:94:y:2004:i:5:p:1276-1302. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Michael P. Albert (email available below). General contact details of provider: https://edirc.repec.org/data/aeaaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.