Informative fund size, managerial skill, and investor rationality

This paper considers the nature of returns to scale in active management following Pástor et al. (2015) who fail to establish diseconomies of scale at the fund level. Using an enhanced empirical strategy, we find a significant negative impact of fund size on performance. This empirical evidence indicates that fund alpha and fund size are not independent entities. Consequently, skill, rather than being measured by the fund alpha, should be measured by the value that a fund extracts from capital markets. We also show that there exist sophisticated investors who correctly exploit positive net present value investment opportunities.