Why do mutual fund expenses matter?

Abstract

This article develops a theory that the intensity of investor monitoring explains much of the relationship between expenses and performance. I instrument for investor monitoring through the use of minimum initial purchase data to test the theory. I find that the highly publicized negative expense-performance relationship disappears among funds that cater to a sophisticated clientele of investors. I find that mainstream investors can use the existence of a share class with a high minimum initial purchase requirement as a signal of competitiveness. My results highlight the important influence investor monitoring has on the competitiveness of financial products. © 2012 Academy of Financial Services. All rights reserved.