Initial Fund Size Anomaly and Its Implication for Returns-to-Scale: Evidence From Japanese Mutual Funds

Abstract

The relationship between the size and return of mutual funds has been a central interest from practical viewpoints. Using the substantial heterogeneity associated with the size of Japanese mutual funds over the early stage of their life cycle, which we call as fund size anomaly, we examine how the returns-to-scale property of mutual funds depend on the initial size of the funds and its size dynamics. Toward this end, first, we document the systematic pattern of the timing for launching fund and find that the fund flows are related to the introduction of new funds. An asset management firm is more likely to launch a fund both when the recently introduced funds attract large inflow and the incumbent funds suffer from large outflow. Second, regarding the reaction of fund flow to the past return, we confirm that fund inflow follows higher past returns, which is consistent with the findings in the extant studies. Third, as the most important results, the returns-to-scale property crucially depends on the initial size and the dynamics of mutual funds. While the funds starting with small size show the widely observed decreasing returns-to-scale, it is not the case for the funds with large initial size and experiencing the reduction in its size. These results jointly suggest that large fund size is driven by the motivations of asset management firms, which results in the biased behavior such as the employment of closet-index strategy.