Capacity Effects and Winner Fund Performance: The Relevance and Interactions of Fund and Family Characteristics

Abstract

In this paper, we investigate the profitability of characteristics-based mutual fund investment strategies. We analyze the existence of capacity effects on the individual fund level and its interactions with fund flows, family TNA, and family size. Recent studies suggest the existence of diseconomies of scale on the individual fund level while assets under management on the family level may not have detrimental effects for fund performance per se. By analyzing a sample of US equity mutual funds between 1992 and 2007 we provide evidence for performance persistence among recent winner funds. After controlling for fund size, we are able to document positive yet insignificant four-factor alphas for the sub-group of small winner funds. When net inflows into these funds are additionally considered, an investment strategy buying small winner funds with below median inflows yields significantly positive four-factor alphas of 2.76 percent per year. Moreover, if the fund family manages few other funds in the same segment, small winner funds weakly outperform the four-factor benchmark by 2.40 percent per year. In contrast, family TNA only provides sufficient information for selecting persistent outperformers among the subset of extremely small winner funds. Overall, the results are rather consistent with the divergence of scale effects on the fund and family level, respectively, and suggest the presence of organizational complexity costs and agency conflicts in large fund families.