Scale, Skill and Returns : An empirical study of returns to scale in the Nordic mutual fund industry

Abstract

This study investigates how fund size and industry size affects the performance of Nordic mutual funds. While the effects of scale in the mutual funds industry has been widely studied in the US, literature specific to the Nordics is scant. Because of this we motivate our hypotheses using existing literature from US markets and investigate this in the Nordics. We begin by sampling 638 actively managed mutual funds that invest in the Nordic mainlands from 2008-2022. After cleaning the data, we apply fund fixed effects and a recursive demeaning procedure to eliminate the omitted variable bias and the finite sample bias. Using this we can investigate the effects of scale and skill in a bias-free setting using multivariate panel regressions. We find empirical evidence of decreasing returns to scale at the industry level. As the size of the mutual funds industry increases in relation to the market capitalization, the ability of a single fund to outperform its designated benchmark decreases. Using the enhanced recursive demeaning estimator from Zhu (2017), we also find empirical evidence of decreasing returns to scale at the fund level. As the size of a single fund increases, its ability to outperform its designated benchmark declines. We also investigate this for each country separately. Every country apart from Denmark shows industry decreasing returns to scale, while every country apart from Sweden shows decreasing returns to scale at the fund level. Next, we investigate the determinants for decreasing returns to scale. We find evidence that funds with a higher turnover-ratio, small-cap trading funds and funds which take more risk are more prone to decreasing returns to scale at the fund level. The evidence is in line with the theory of liquidity constraints from Berk and Green (2004). We could however not find any evidence of these determinants at the industry level. Finally, controlling for the effects of scale we investigate skill in the Nordic mutual fund industry. Our study shows that the Nordic mutual funds industry is skilled, and that skill increases over time. However, because of an increasing industry size, and an increase in the average fund size this has failed to translate into higher benchmark-adjusted returns.