NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Fund Tradeoffs

Lubos Pastor, Robert F. Stambaugh, Lucian A. Taylor

NBER Working Paper No. 23670
Issued in August 2017, Revised in December 2017
NBER Program(s):Asset Pricing

We derive equilibrium relations among active mutual funds' key characteristics: fund size, expense ratio, turnover, and portfolio liquidity. As our model predicts, funds with smaller size, higher expense ratios, and lower turnover hold less liquid portfolios. A portfolio's liquidity, a concept introduced here, depends not only on the liquidity of the portfolio's holdings but also on the portfolio's diversification. We derive simple, theoretically motivated measures of portfolio liquidity and diversification. Both measures have trended up over time. We also find larger funds are cheaper, funds trading less are larger and cheaper, and excessively large funds underperform, as our model predicts.

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Document Object Identifier (DOI): 10.3386/w23670

 
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