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Reader’s question: Does a small-cap fund's size hurt its performance? - Anonymous
Yes, it can. But it is not a reason to avoid small-cap funds entirely. It is a reason to understand what happens inside them as they grow.
Why size becomes a problem in small-cap funds
Small-cap funds invest in companies with relatively small market values, typically between Rs 1,000 and 5,000 crore. When a fund managing Rs 200 crore wants to take a 5 per cent position in a Rs 1,000 crore company, it needs to buy Rs 10 crore worth of shares. That is manageable. The fund can build the position without meaningfully moving the stock price.
Now imagine the same fund has grown to Rs 2,000 crore. The same 5 per cent allocation now requires Rs 100 crore, which could mean owning 10 per cent of the entire company. Finding enough sellers at a fair price becomes difficult. And when it is time to exit, selling that much stock in a thinly traded company can push the price down, hurting the very returns the fund is trying to protect.
This is the core problem: small-cap stocks simply do not have enough daily trading volume to absorb large positions without the fund itself moving the market.
What fund managers do when the fund gets too large
Faced with liquidity constraints, fund managers typically do one of two things. They spread the portfolio across more stocks to deploy the capital, which can dilute returns, since the fund is no longer concentrating on its best ideas. Or they drift toward larger, more liquid companies that are easier to trade in size, which gradually changes the character of the fund.
Neither is ideal. Both are the natural consequence of size in a narrow market.
There is also what might be called the winner's curse. A small-cap fund that delivers exceptional returns attracts large inflows. Those inflows make it harder to maintain the same strategy. The fund that earned its reputation by being nimble and concentrated becomes, over time, broader and more constrained, simply because of its own success.
Is there a size limit?
There is no precise threshold. The tipping point depends on the fund manager's strategy, the liquidity of the specific stocks held and broader market conditions. A fund with a highly concentrated portfolio in illiquid names will feel the pressure of size much earlier than one that is already broadly diversified.
What is observable is the direction. As AUM—assets under management, the total money the fund manages—grows, the fund's ability to take high-conviction positions in genuinely small companies diminishes. This shows up gradually in portfolio disclosures: more stocks, higher average market cap, longer time needed to exit positions.
What to watch as an investor
A large small-cap fund is not automatically a poor investment. Several fund houses manage this by temporarily suspending fresh lumpsum investments or new SIPs—systematic investment plans—when they believe the fund has reached a size that limits their strategy. That is a sign of disciplined management, not distress.
As an investor, the more useful questions are: has the stock count risen sharply over the past two to three years? Has the average market cap of holdings crept upward? How long would the fund take to exit half its portfolio if needed, a figure now disclosed monthly by fund houses for mid and small-cap funds?
These signals matter more than the AUM number alone. A fund can be large and still well-managed. A fund can be small and still poorly run. The size is the starting point for the question, not the answer to it.
Also read: How to pick a fund without being fooled by past returns?
This article was originally published on January 08, 2025, and last updated on May 28, 2026.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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