A new study finds that scalability is the most important factor in creating value in mutual funds, while investment skill, age of fund and quality of information also play a role
A new journal article finds that value is generated by a mutual fund’s skill at spotting profit-making ideas in combination with how easy it is to bring these ideas to scale. The research by Prof. Olivier Scaillet of the Geneva School of Economics and Management (GSEM) finds that great investment ideas tend to be difficult to scale up, but that scalability is the most important factor in creating value. Overall, direct investment and small cap funds were found to offer better value than funds sold through brokers and large cap funds.
The article “Skill, Scale, and Value Creation in the Mutual Fund Industry”, co-authored by Laurent Barras (Desautels Faculty of Management, McGill University) and Patrick Gagliardini (University of Lugano), is published in the Journal of Finance. It finds that values appreciate following an adjustment period, as investors learn more about the potential of their investments. Older funds tend to generate more value, while the number of underachieving funds decreases over time as investors get better at accessing and evaluating information.
Most funds are run by skilled managers and create large profits. However, 63% of funds have a negative return on investment. This may be due to funds overestimating their performance and charging fees that are too high. “A big part of the problem is the quality of information available to investors,” says the paper’s author Professor Scaillet, “better, more timely information could help them switch to cheaper funds.”
Most studies on mutual funds focus on performance (the value passed on to investors), while little is known about skill (a fund’s unique ability to create value through trading). This new approach analyses the role of skill and scalability in creating value across five decades of US mutual funds (1975-2019). Skill and barriers to scalability are highly variable, strongly correlated and shape the distribution of value generated across these funds.
> Link to the article on “Skill, Scale, and Value Creation in the Mutual Fund Industry“
November 12, 2021