The Small IPO and the Investing Preferences of Mutual Funds

We examine how liquidity and return concerns at large mutual funds explain their diminished participation in small IPOs since the late 1990s. Using 5825 IPOs and portfolio-level information for 37,052 funds, we exploit Russia’s 1998 debt default as an exogenous shock to funds’ liquidity concerns. After 1998, large funds invested in fewer small/illiquid IPOs and more large/liquid IPOs than smaller funds and received higher returns for small IPO investments. Given increased fund sizes since 1990, these results are consistent with funds’ liquidity concerns and their demand for greater compensation when investing in transactions representing a trivial fraction of fund assets.