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

Sales charges are the commissions that you may have to pay when you buy or sell a fund. If you pay this charge when you buy the fund, it’s called an initial sales charge or front-end load. If you pay it when you sell, it’s called a deferred sales charge or back-end load. Some funds are sold on a “no-load” basis, which means you pay no sales charge when you buy or sell. Comparing sales charge options With initial sales charges, the cost can vary from firm to firm and may be negotiable. Shop around, and remember that every dollar you pay in commission is a. | Does Fund Size Erode Mutual Fund Performance The Role of Liquidity and Organization By Joseph Chen Harrison Hong Ming Huang and Jeffrey D. Kubik 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. JEL G2 G20 G23 L2 L22 The mutual fund industry plays an increasingly important role in the . economy. Over the past two decades mutual funds have been among the fastest growing institutions in this country. At the end of 1980 they managed less than 150 billion but this figure had grown to over 4 trillion by the end of 1997 a number that exceeds aggregate bank deposits Robert C. Pozen 1998 . Indeed almost 50 percent of households today invest in mutual funds investment Company Institute 2000 . The most important and fastest-growing part of this industry is funds that invest in stocks particularly actively managed ones. The explosion of newsletters magazines and such rating services as Morningstar attest to the fact that investors spend significant resources in identifying managers with stock-picking ability. More important actively managed funds control a sizeable Chen Marshall School of Business .

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