Choose mutual funds and ETFs with a minimum economical portfolio size If you are going to invest in actively managed funds, then you should want them to have a sufficiently large asset base to fund the necessary research.
If an active fund is too small, then fund management quality can suffer or fees could grow. Index funds do not have the significant overhead that active funds have, which is associated with evaluating investment alternatives. Because of their much lower costs, the minimum size of passively managed index funds can be much less an issue than it is with an actively managed fund.
To amortize the management expenses that are necessary to manage properly an actively managed mutual fund or ETF each year, some minimum total asset figure is required. To illustrate, an actively managed $100M equity mutual fund with a 1% expense ratio yields $1 million annually for management expenses.
In the grand scheme of what it takes to run an actively managed mutual fund or ETF each year, $1M is just not a lot of money. Therefore, it would be reasonable for you to set your minimum asset selection criteria at several hundred million dollars or even higher for an actively managed equity mutual fund.
If your maximum annual management expense screening criterion were lower than 1%, then the required asset base would need to be proportionately higher. If the expenses of a particular “style” of active fund, such as emerging markets equities, tend to be even higher, then you would want an even larger asset base over which to spread active management costs.
While the scientific investment literature indicates that passive index fund strategies lead to better net performance on average, The Skilled Investor does not expect that actively managed funds will disappear. Therefore, if you still are going to invest in actively managed funds, then you should want them to have a sufficiently large asset base to fund the necessary research. If an active fund is too small, then fund management quality could suffer and/or fees could grow.
The problem with active professional fund management is not that there is no “gross” value added. On average, fund management professionals make a positive contribution before their expenses. They may be doing so at the expense of amateurs who are poor portfolio self-managers. (See: What is the cost to individual investors of sub-optimal portfolio diversification?)
The problem with active [...]