Asset Size and Mutual Funds: Why Nothing Fails Like Success (Chapter 12)

Book: Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition by John C. Bogle ISBN: 978-0-470-59748-4

Bogle gives this chapter one of his best subtitles: “Nothing Fails Like Success.” And if that sounds backwards to you, that’s exactly the point.

The mutual fund industry experienced explosive growth in the decades Bogle covered. Equity fund assets went from $34 billion to $2.8 trillion in about 20 years. That’s not a typo. That’s an 80x increase. And by the time Bogle was writing, mutual funds owned 21% of corporate America, up from just 2.8% in 1982.

Sounds like a success story, right? More money, more investors, more assets. But here’s the problem. What’s good for the fund company is not necessarily good for the fund investor. And size, it turns out, is one of the biggest enemies of investment performance.

The Physics of Being Big

Think about it practically. A small fund with $100 million in assets can buy meaningful positions in small and mid-sized companies without moving the stock price. A large fund with $50 billion? It can’t.

When a massive fund tries to buy shares in a smaller company, the buying itself pushes the price up. By the time they’ve accumulated a full position, they’ve driven the price higher than where they started buying. Same thing in reverse when they sell. They push the price down as they exit.

These transaction costs are real, and they get worse as the fund gets bigger. The fund’s own trades work against it.

But it gets worse. A huge fund can’t even invest in small stocks meaningfully. If a $50 billion fund puts 1% of its assets into a small company, that’s $500 million. Many small companies don’t even have that much stock available to buy. So large funds are forced to concentrate on large-cap stocks. Which means they start looking a lot like the index. Which means they become closet indexers. Which means you’re paying active management fees for what’s basically an index fund.

The Success Trap

Here’s how the trap works. A fund manager does well. Money pours in. The fund gets bigger. And the very strategies that made the fund successful become harder or impossible to execute at the new scale.

The small-cap stock picker who was crushing it with a $200 million fund? Give them $10 billion and they can’t do the same thing anymore. The trades are too big. The stocks are too small. The edge disappears.

But does the fund company step in and close the fund to new investors? Almost never. Because more assets means more fees. A fund charging 1% on $10 billion generates $100 million in annual revenue. On $200 million, that’s only $2 million. No fund company voluntarily walks away from that kind of money.

So the fund stays open. Money keeps flowing in. Performance degrades. And the investors who came in because of the great track record are the ones who suffer.

The Consolidation Problem

Bogle also pointed out something about the industry structure that matters. By the time he was writing, only 3 of the top 25 fund complexes were standalone fund companies. The rest had been absorbed into banks, insurance companies, or financial conglomerates.

Why does this matter? Because the parent company’s primary goal is maximizing profits for its own shareholders. Not for the fund’s shareholders. Those are two completely different groups with completely different interests.

The fund company wants to gather more assets, charge higher fees, and create more products to sell. The fund shareholder wants low costs, disciplined management, and good returns. These goals are fundamentally in conflict.

And the conglomerates won. Fund companies kept creating new funds, not because investors needed them, but because new products attract new money. Got a hot market sector? Launch a sector fund. New trend? Launch a thematic fund. It doesn’t matter if investors need 47 different fund options. What matters is that each new fund is another revenue stream.

The Industry Solution: More Funds, Not Better Funds

This is the part that really gets to me. When faced with the problem that large funds underperform, the industry’s response wasn’t to manage existing funds better. It was to create more funds.

Fund companies launched hundreds of new funds. Different styles, different sectors, different strategies. Not because there was genuine investor demand, but because more funds meant more opportunities to attract assets and charge fees.

And here’s the cynical math. If you launch 20 new funds, some of them will do well purely by chance. Those are the ones you advertise. The ones that underperform? You quietly merge them into other funds or shut them down. The bad track records disappear. Only the good ones survive to be marketed.

This survivorship bias makes the industry look better than it actually is. If you only count the funds that still exist, average performance looks OK. But if you include all the funds that were launched and then killed off because they stank, the picture is much worse.

The Conflict of Interest

Fund managers personally benefit from larger assets. Their compensation is usually tied to the amount of money they manage, not how well they manage it. A manager earning 0.5% on $20 billion makes $100 million for the firm. The same manager earning 0.5% on $1 billion makes $5 million.

So the incentive is always to gather more assets. Even if the fund is already too big to execute its strategy effectively. Even if new money flowing in will dilute returns for existing shareholders. The manager gets paid more, the fund company gets paid more, and the shareholders get worse performance.

This is one of those structural problems that individual investors can’t fix. You can’t make your fund company close the fund to new investors. You can’t force them to prioritize your returns over their revenue. The only thing you can do is understand the dynamic and make choices accordingly.

Bogle’s Dream

Bogle’s solution was the same one he’d been advocating his entire career. A truly mutual structure where the fund company is owned by the fund shareholders themselves. Where scale benefits flow to the investors, not to outside owners.

That’s what Vanguard is. The fund shareholders own the fund company. So when the company gets bigger and more efficient, those savings get passed along as lower fees. There’s no outside owner extracting profits.

Bogle acknowledged this was a radical idea. And decades later, Vanguard is still basically the only major fund company structured this way. The rest of the industry has moved in the opposite direction, with more consolidation, more conglomeration, and more conflict of interest.

This Has Only Gotten Worse

Since Bogle wrote this, the numbers have gotten even more extreme. Total mutual fund and ETF assets in the US are now measured in the tens of trillions. The largest funds are enormous. The biggest fund complexes manage staggering amounts of money.

And the pattern Bogle described has continued. Massive funds underperform. Fund companies keep creating new products. Survivorship bias keeps making the industry look better than it is. The conflicts of interest haven’t gone away.

The good news? Investors have increasingly figured this out. The shift toward index funds and ETFs has been massive. Trillions of dollars have moved from high-cost active management to low-cost indexing. Bogle’s ideas won, even if the industry structure he dreamed about never became the norm.

But for anyone still in expensive, bloated actively managed funds, the lesson from this chapter is clear. Size is not your friend. And the fund company’s success is not the same as your success.

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