Size Doesn't Matter | Value Research The size of a mutual fund, in terms of the money it manages, has no bearing on its performance

Size Doesn't Matter

The size of a mutual fund, in terms of the money it manages, has no bearing on its performance

A remarkably persistent misbelief among mutual fund investors is that the size of a mutual fund matters. By size, I mean the amount of money that a fund manages, the industry jargon for which is Assets Under Management (AUM). This belief has no basis in reality. There's no inherent reason that a larger fund is better than a smaller one. If a smaller fund has a better track record for risk-adjusted returns than a larger fund of the same type, then by all means investors should choose the smaller one. Of course, this belief persists not because of some fault of the investors themselves because it is actively promoted by the marketers of large funds as it gives them an additional handle to promote their fund against some other that may be doing better.

Is there any basis to this belief? It does happen that compared to smaller funds, a relatively greater proportion of larger funds have good performance. However, there are many lousy large funds and there are many great small funds. As an investor, you must not fall in to the trap of confusing cause with effect. Funds that have a long track record of good performance tend to get large as more and more investor money flows in to them, and this money has a long time to grow. However, do look at the previous sentence carefully. They were good, so they eventually became large.

The reverse is not true. You can't pick a random large fund and say that just because it's large it must be good. Equally, you can't pick up a smaller fund with good performance and say that its performance does not matter and you must not invest in it because it's small. Apart from good performance, there are many variables that can make a fund large or keep it small. The marketing prowess of a fund company or the reach and clout of its parent among fund distributors are the biggest reasons. There can be others. For instance, there are a number of equity funds that started out large on day one because they had hugely hyped NFOs at the peak of the markets. Some of these have turned out be very poor performers but they are still large.

It so happens that there are a number of relatively small equity funds in the fund industry that have displayed good long-term performance and are definitely worth a look. Whenever an investor wants to invest in such a fund, or when an analyst like me praises them, those selling larger funds dismiss the idea contemptuously. “But you can't compare a Rs 2,000 crore fund to a 100 crore one!” they protest. This is a red herring. To the investor, it is irrelevant that a fund is small or a fund company does not measure up in the fund industry's pecking order. If a fund has a good track record and a high rating from Value Research, then size doesn't matter.

Does that mean that there no circumstances under which fund size matters? There are, and interestingly enough, size is a disadvantage for some types of large equity funds. For example, funds focussing on small and mid-cap stocks may not be able to find enough stocks that they can invest in.

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