A Study On The Relationship Between Fund Performance And Fund Size And Its Mechanism

This paper investigates how fund size and fund family size influence fund performance differently. And then this paper tries to explore the mechanism behind the heterogeneity of the influence.With rapid progress of mutual funds in China, people must tackle an issue that is fundamental to understanding the role of these mutual funds in Chinese economy-the economies of scale in the mutual fund industry. Namely, how does performance depend on the size or asset base of the fund and the fund family? A better understanding of this issue would naturally have profound implications for investors, the issue of the persistence of fund performance, the agency relationship between managers and investors and the optimal compensation contract between them.I believe that thorough understanding of the economic nature of enterprises is the internal force driving the theories of the relationship between fund performance and fund size continuously moving ahead. Therefore this paper classes the theories of the relationship between fund performance and fund size as follows:the Liquidity Hypothesis based on the Neo-Classical Theory, the Management Capability Hypothesis based on the Principal-Agency Framework and the Soft Information Hypothesis based on the Transaction Cost Economics.With the data of Chinese open-ended stock mutual funds which spans June 2005 to December 2009 as the sample, this paper documents that fund returns, both before and after fees and expenses, always decline with lagged fund size and increase with lagged fund family size, even after accounting for various performance benchmarks.Finally, this paper explores the applicability of the theories of the relationship between fund performance and fund size in the mutual fund industry in China and empirically examines the three hypotheses. Empirical results indicate that the Liquidity Hypothesis and the Management Capability Hypothesis cannot explain the relationship between fund performance and fund size in China, and the relationship is due to the Soft Information Hypothesis based on the Transaction Cost Economics. The three inferences from the Soft Information Hypothesis are also been empirical examined:with the number of fund managers increasing, fund performance declines; a star fund's performance is not correlated with its size, and is still positively correlated with its fund family size, but the star fund's performance is more sensitive to the number of fund managers than a general fund; the optimal fund size is changing.