Higher Fund Assets Can Lead to Poorer Fund Performance

Research recently released by Duke University shows that “greedy” funds with rising asset levels can return poorer performance for investors, according to an article in Institutional Investor.

Evidence presented in a new study by researchers at Duke University and Texas A&M University indicates that “alpha diminishes significantly as individual funds grow and as industry assets under management rise,” the article says. Higher assets lead to higher income from management fees and profits, it says, but this can translate into underperformance for investors.

The study analyzed data from domestic equity funds for the period between 1991 and 2001 and found that, for an average fund that doubled its size over the course of a year, “alpha fell by 20 basis points annually. Excess returns also decreased by five basis points for the average fund with each 1 percent increase in overall industry size per month.”

That said, the researchers also found that the flow into funds is lower if they demonstrate decreasing “returns to scale” which indicates that investors are paying attention to this metric. The study authors conclude, “Decreasing returns to scale should be of first-order importance in the decision to allocate to a particular fund.”