DP12513 Fund Tradeoffs

Author(s): Lubos Pástor, Robert F. Stambaugh, Lucian Taylor
Publication Date: December 2017
Date Revised: October 2018
Keyword(s): Diversification, Mutual funds, portfolio liquidity
JEL(s): G11, G23
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12513

We derive equilibrium relations among active mutual funds' key characteristics: fund size, expense ratio, turnover, and portfolio liquidity. Portfolio liquidity, a concept introduced here, depends not only on the liquidity of the portfolio's holdings but also on the portfolio's diversification. As our model predicts, funds with smaller size, higher expense ratios, and lower turnover hold less-liquid portfolios. Additional model predictions are also supported empirically: Larger funds are cheaper. Larger and cheaper funds trade less and are less active, based on our novel measure of activeness. Better-diversified funds hold less-liquid stocks; they are also larger, cheaper, and trade more.