Essays On Fund Management

This dissertation contains two chapters on the topic of fund management. The first chapter explores an important question in hedge fund management on whether hedge funds experience decreasing returns to scale, as hedge fund managers often pursue arbitrage opportunities which are limited and short-lived. Extant literature has presented evidence of decreasing returns to scale at the hedge fund level. Employing a newly developed, unbiased estimation method based on recursive demeaning, I find no evidence of decreasing returns to scale at the hedge fund level. However, I do find evidence that hedge fund returns are decreasing in hedge fund industry size. Further tests suggest that inter-hedge fund competition drives this result. Additionally, I examine the evolution of raw managerial skill of hedge funds over time and find that fund performance deteriorates as funds grow older, but this does not take away from the detrimental effects on performance due to the industry becoming more competitive.The second chapter is on the subject of style drift in mutual fund management and documents that small-cap mutual funds allocate on average 27% of their portfolio to mid- and large-cap stocks. I find that larger and older small-cap funds are more likely to hold mid- and large-cap stocks, consistent with funds straying from their objective over time. Funds that invest heavily in mid- and large-cap stocks expose their investors to unanticipated risks but investors do not experience higher abnormal returns or performance persistence overall. These funds did outperform their peers by 3% annually in the most recent period between January 2003 and March 2010.