Scale and Performance in Active Management are Not Negatively Related

We revisit the nature of returns to scale following Pastor, Stambaugh, and Taylor (2015). Using replicated versions of their domestic equity fund sample, we confirm their negative and significant relation between industry scale and performance. However, upon closer examination we find the diseconomies of scale at the industry level result is an artifact of data errors that comprise less than 0.05% of the sample―168 out of 332,516 observations―that occurred most often in the year 2000. We are unable to find industry level diseconomies of scale in the post 2001 era. A major source of these errors is the incorrect use of Morningstar’s current performance benchmarks to measure historical return performance. We confirm the non-result findings using Fama-French three-factor adjusted returns, which are not subject to benchmarking errors.