Small Isn't Always Beautiful

Most mutual fund observers believe that size hurts. As funds (and fund companies) grow larger, they become cumbersome. Their assets outstrip their best ideas, forcing them either to dilute their portfolios by moving down their buy lists or to hike their trading costs by pumping too much money into their favorite securities. Thus come the debates about when to close funds that have become too large, and the barbs directed at “greedy” fund companies that keep their doors open.

Most fund observers are probably right. Last year, three professors found that new, small mutual funds tended to outperform their older, larger peers. The professors argued that those results are primarily because younger managers are more skilled (having more recently attended business school, learning the latest tricks), but they acknowledged that immobility was also a factor. Clearly, funds that invest in niche, illiquid markets and that trade frequently will quickly struggle with incoming assets. So, too, will many funds that hold concentrated portfolios.