Liquidity, investment ability, and mutual fund structure

We develop a model of the mutual fund industry in which the management fees and loads charged by actively managed open-end funds and average fund retu rns are determined endogenously in a competitive market setting. It is show n that heterogeneity in managerial skills at investing and minimizing costs , and the existence of investor clienteles with differing liquidity and mar keting needs, gives rise to a variety of open-end fund structures that diff er in the average return delivered to investors. Managers choose a fund's s tructure to maximize the rents they capture from their ability, taking into account the effect on investor flows. In equilibrium, funds that constrain liquidity withdrawals may have to charge lower fees and share some profits in the form of higher investor returns, when there is relative scarcity of investors with low liquidity needs. (C) 2000 Elsevier Science S.A. All rig hts reserved. JEL classification: C23; L14; L22.