Does Size Affect Performance?: A Study of Size-Driven Effects on Performance in Swedish Equity Mutual Funds

Abstract: This thesis analyzes the effect of mutual fund size on performance by studying 59 Swedish equity mutual funds over the period July 1998 to June 2008. We argue that size can be seen as a “proxy” for capturing the effects of various factors affecting performance and driven by size. The size-driven factors tested in this thesis include liquidity costs, economies of scale in mutual fund families, extreme net flows and persistence in performance. Using regressions and analyzing these factors by dividing funds into groups based on fund size, we find that there is no significant relation between size and performance between groups over the ten year period, even though small funds appear to earn higher excess returns. Our results indicate that liquidity costs are present in the Swedish equity market and significantly increase with fund size. Our results also show that there are diseconomies to scale from being part of the largest fund complexes in the Swedish market. For the half of smallest funds in the sample belonging to these complexes, we find that they significantly underperform their peers. Bureaucracy and star-phenomenon among complexes are possible explanations for these diseconomies. Our findings for extreme net flows contradict the presented theory. Extreme net flows prove to have a significant positive impact on funds’ performance. Our sample of funds also displays significant persistence in underperformance among all funds over the ten year period. Persistence however does little to explain the observed results between size and performance. Over all our results indicate that investors should focus on diversifying amongst small funds not belonging to the largest fund complexes. Fund managers should understand the changing effect of size-driven factors on performance, and develop strategies for how to handle these.