How Much Does Size Erode Mutual Fund Performance? A Regression Discontinuity Approach

Although mutual funds exhibit little ability to persistently outperform their peers, money flows into funds with the highest past returns. Berk and Green (2004) rationalize these patterns by arguing that more-skilled managers manage more assets but, because of diseconomies of scale, generate the same expected returns as less-skilled managers. To identify the causal impact of fund size on performance, we exploit the fact that small differences in mutual fund returns can cause discrete changes in Morningstar ratings that, in turn, generate discrete differences in mutual fund size. Our regression discontinuity estimates yield little evidence that fund size erodes fund returns.