Which way does the arrow point? Fund size and returns

Question

A marketing deck shows that funds with larger assets under management (AUM) had stronger trailing returns, and concludes: "Scale drives performance, so invest in the biggest funds."

Give the more plausible causal direction and explain why the naive reading is likely backwards.

Accepted Answer

This is reverse causation. The naive story is AUM causes returns; the likelier story is returns cause AUM. Strong past returns attract investor inflows, which grow a fund's AUM. So performance drives size, not the other way around: good returns come first, the money follows. The funds that are big today are disproportionately the ones that performed well yesterday, which is exactly the correlation the deck shows, with the arrow pointing the opposite way from its claim. If anything, the true effect is negative. Large AUM tends to hurt future returns: bigger positions face capacity limits, mark…

Which way does the arrow point? Fund size and returns

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