We exploit heterogeneity in decreasing returns to scale parameters across funds to analyze their e¤ects on capital allocation decisions in the mutual fund market. We …find strong evidence that steeper decreasing returns to scale attenuate ‡ow sensitivity to performance, which has a large e¤ect on equilibrium fund sizes. Our results are consistent with a rational model for active management. We argue that an important fraction of cross-sectional variation in fund sizes is due to investors rationally anticipating the effects of scale on return performance.​