Bigger Is Not Better
Yesterday’s column set forth the notion that many mutual fund managers have substantial skill, but investors rarely reap the benefits. The best managers are quickly identified by fund buyers and swamped with incoming assets, to the point where the harm caused by the difficulty of investing the new assets neutralizes the manager's skill, causing the fund to subside to average performance.
It's not my notion, it is that of business school professors Jonathan Berk and Richard Green. The theory is attractive because it offers a rational explanation for the observed behavior of the mutual fund marketplace. Under Berk and Green, investors don’t buy actively managed funds because they are brain-dead stupid, thereby violating the basic economic principle of rational self-interest. Instead, investors buy actively managed funds for the sound reason that that professional managers are good.
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John Rekenthaler does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.