Mutual fund economies of scale: Nature and sources

Abstract

The mutual fund discussions include the following select findings: (1) There are economies of scale in fund administration; (2) the average fund exhibits cost economies of scale; (3) fund size greatly reduces performance; (4) fund expense ratios are consistent with economies of scale at both fund and fund family levels; (5) fund economies of scale are very much in evidence; (6) economies of scale are primarily driven by the smallest one-third of funds; (7) on average, institutional funds have larger economies of scale than retail funds; (8) scale effects in trading, rather than other factors, are the primary cause of decreasing returns to scale; (9) the proximate cause of fund diminishing returns to scale is inability to scale investment strategies as fund size increases; (10) whether focus is on preferred regression discontinuity estimates or estimates based on changes in Morningstar ratings, there is little evidence that fund size erodes performance; (11) as industry size increases, fund manager ability to outperform passive benchmarks declines; (12) expenses decline with fund size, with expenses other than management fees having the largest impacts; (13) fund families preferentially allocate the best investment strategies to smaller funds, which results in negative relations of fund size to performance in the largest fund families; and (14) actively managed funds provide strong evidence of decreasing returns to scale.