Does Fund Size Erode Mutual Fund Performance?

With the development of Chinese mutual fund market, the size of per fund tendsto be much larger than before. Using the data of actively managed Chinese open-endequity funds, this paper carefully studies the fundamental fund size performance issue,that is, whether larger fund size leads to better return. Risk-adjusted fund returns byvarious benchmarks are regressed on lagged fund size and a set of fund characteristicssuch as age and turnover. Both cross-sectional and panel regression indicate aninverted U-shaped relationship between fund size and fund performance in theChinese context.Then the paper explores potential explanations for such a relationship to existand mainly focus on economies of scale, liquidity and organizational issues. Largerfunds enjoy economies of scale both from fixed expense ratio and commission rate.On the other hand, liquidity tends to distract fund performance as the size builds upwhile the number of holding stocks does not grow proportionally. Facing greatermarket impact, larger funds have to think twice when constructing portfolio and havea much lower turnover rate. In terms of organizational issues, the return differencebetween team-managed funds and solo-managed ones is not statistically important.However, other organizational issues such as incentive mechanism and softinformation processing efficiency may help explain the unfavorable performance oflarge fund.