Mutual Fund Economies of Scale : Nature and Sources

The literature has been unable to provide a definitive model of the sources and nature of mutual fund scale economies and diseconomies. This study provides findings on the sources and nature of fund economies and diseconomies with respect to expenses, size, performance, trading, and numerous other factors. 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 the focus is on preferred regression discontinuity estimates or estimates based on changes in Morningstar ratings, there is little evidence 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. 14. Actively managed funds provide strong evidence of decreasing returns to scale