Scale and Skill in Active Management

We empirically analyze the nature of returns to scale in active mutual fund management. We find strong evidence of decreasing returns at the industry level: As the size of the active mutual fund industry increases, a fund’s ability to outperform passive benchmarks declines. In contrast, estimates that avoid econometric biases do not detect decreasing returns at the fund level. We also find that funds born more recently exhibit more skill. This upward trend in skill coincides with industry growth, which precludes the skill improvement from boosting fund performance. Finally, we find that performance deteriorates over a typical fund’s lifetime. This result can also be explained by industry growth and industry-level decreasing returns to scale. *Pástor is at the University of Chicago Booth School of Business. Stambaugh and Taylor are a