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Abstract:I provide evidence that the negative aggregate benchmark-adjusted performance of actively managed equity mutual funds is caused mainly by the poor performance of a small group of oversized funds. Many mutual fund investors behave as though they rely on the Capital Asset Pricing Model. They confuse the effects of fund exposures to other common factors with managerial skill. Actively managed mutual funds with positive factor-related past returns thus accumulate assets to the point that they significantly underperform. My model predicts that less skilled active fund managers tilt their portfolios toward common factors so as to gather more flows and collect more fees. I find empirical support for this prediction in actively managed mutual fund data. My results thus imply that skill and scale are mismatched in the mutual fund industry.

Graduate School of Business, Stanford University

Yang Song (宋阳）is currently a finance PhD at Graduate School of Business, Stanford University. He completed a B.S. in Mathematics from Fudan University and a M.S. in Financial Mathematics from Stanford University. His awards and honors include Jun Liu Mathematics Memorial Award, Top-Ten Excellent Graduate of Fudan University, among many others. His research has spanned a variety of fields, including financial intermediation, macro-finance, over-the-counter (OTC) markets, financial accounting, active asset management, and monetary policy. His research has been covered by media including Bloomberg TV, Bloomberg Business, Risk.