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FIIE-14: Delegated Portfolios
Skill and Value Creation in the Mutual Fund Industry
1McGill University, Canada; 2University of Lugano, Switzerland; 3University of Geneva, Switzerland
We develop a simple, nonparametric approach for estimating the entire distribution of skill. Our approach avoids the challenge of correctly specifying the distribution, and accommodates the need to study both the investment and trading dimensions of skill. Our results show that most funds are skilled at detecting profitable trades, but unskilled at overriding capacity constraints. Aggregating both skill dimensions, we find overwhelming evidence that mutual funds produce significant value added. In addition, the active industry is (i) not concentrated because few funds are skilled on all dimensions, (ii) close to optimally sized as funds internalize the impact of capacity constraints, and (iii) in a strong bargaining position vis-a-vis the investors.
Do Buyside Institutions Supply Liquidity in Bond Markets? Evidence from Mutual Funds
1Southern Methodist University, United States of America; 2Syracuse University, United States of America
We examine the role of buy-side institutions as liquidity suppliers in bond markets. Focusing on mutual funds, we classify a fund’s trading style as liquidity supplying (demanding) if the fund helps absorb (strain) dealers’ inventory. While mutual funds in aggregate demand liquidity, persistent cross-sectional variation exists – stable funding, family affiliation with dealers, and fund manager skill are associated with liquidity supply. Liquidity supplying trading style earns higher alpha, especially in illiquid markets. Our evidence suggests that bond market liquidity can be enhanced by removing institutional frictions that impede broad investor participation in liquidity provision.
Returns to Scale in Active and Passive Management
1University of Texas at Arlington, United States of America; 2University of Georgia, United States of America; 3Virginia Tech, United States of America
We examine the nature of returns to scale in active and passive management. After correcting for data errors in the merged CRSP-Morningstar database that comprise less than 0.05% of the sample observations, we find an insignificant relation between scale (at both the fund and industry levels) and return performance in actively managed mutual funds. We reconcile non-negative returns to scale with Berk and Green (2004) using index funds to proxy for the passively managed component of actively managed funds and find an inverse relation between non-expense-ratio operating costs and fund size. We argue this decline offsets diseconomies of scale in active management.
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