Think bigger is better? Not in mutual funds

Summary: Big mutual funds may look safe and unstoppable until you check their long-term record. Our data across four categories shows how scale that once boosted returns can quietly flatten them. Are investors chasing comfort or real performance? Let’s find out.

In the mutual fund business, success feeds on itself. A few strong years and money flows in. The fund grows, its visibility rises and investors take its size as proof of reliability. India’s equity funds illustrate this perfectly. The 10 largest flexi-cap schemes now control 78 per cent of the category’s total assets, while the 10 largest large-cap funds manage almost 90 per cent. For investors looking at size as a proxy for safety or skill, the logic seems intuitive: so many people cannot be wrong.

In the short term, that assumption appears sound. Over the past year, seven of the 10 biggest flexi-cap funds and eight of the 10 largest large-cap funds outperformed their benchmarks and category averages. It is a comforting pattern: the biggest funds seem to deliver results that justify their popularity.

But comfort and performance rarely move in tandem for long. The same scale that provides liquidity and lowers costs in the near term often limits flexibility and erodes alpha over time.

In categories dominated by large, liquid stocks – such as large-cap and flexi-cap funds – scale can enhance efficiency. These managers can trade substantial positions in blue-chip companies without moving the market. That helps explain their dominance over the past year.

The pattern, however, weakens as one moves down the size spectrum. Mid-cap and small-cap funds operate in markets where liquidity is thin and trade sizes matter. When a fund managing Rs 20,000–30,000 crore tries to buy or sell smaller companies, prices move before the order is complete. Last year, none of the 10 largest mid-cap funds managed to beat their benchmarks; in small caps, only three out of 10 did.

Short-term data, though, doesn’t paint the full picture. To test whether size truly signals skill, one must look further back.

Does size matter in the long run?

The longer view offers a more sobering perspective.

The data reveal a mixed picture. In the large- and flexi-cap categories, scale continues to coincide with strength. Roughly half to two-thirds of the largest funds outperformed over three years, suggesting that their processes, access and brand stability helped sustain results beyond a single cycle.

But the relationship unravels quickly as one moves into the mid- and small-cap space. There, the largest funds not only fell behind peers but also underperformed their own benchmarks. Collectively, the top 10 funds in these segments manage over 80 per cent of the category’s assets, enough to influence prices but apparently too much to generate consistent alpha. To put the excess money to work, managers of these large funds may have to buy already expensive stocks or spread their investments too thin across many companies. Both these actions can reduce returns.

Five-year data make the trend unmistakable. Across all categories, outperformance has narrowed to fractions of a percentage point. The top 10 large-cap funds, which together controlled over 95 per cent of their category’s assets (actively managed funds) five years ago, delivered an average return of 19.8 per cent, barely ahead of their benchmark’s 18.5 per cent.

Flexi-cap giants saw an even thinner margin, 21.3 per cent against 20.8 per cent. In mid- and small-cap categories, the largest funds now trail their benchmarks. Out of 10, only six mid-cap and four small-cap funds managed to outperform.

Why size cuts both ways

The arithmetic of scale is unforgiving. A fund managing Rs 40,000 crore cannot behave like one managing Rs 4,000 crore. Every inflow dilutes focus; every rebalance must be executed gradually to avoid moving prices. Over time, the freedom to act quickly or decisively, a crucial source of alpha, is lost.

That loss is clearest in mid- and small-cap funds, where liquidity is limited. The top funds here often own meaningful stakes in the same handful of companies, turning the segment itself into a crowded trade. When one large player adjusts its portfolio, others must follow, reinforcing price swings.

In contrast, large-cap funds enjoy structural advantages. They invest in large companies, thus facing fewer liquidity constraints and can scale without distortion.

That said, the story also underscores the rarity of funds that combine both size and sustained outperformance. Nippon Small Cap, Mirae Asset Midcap, Parag Parikh Flexi Cap and HDFC Flexi Cap stand out as exceptions. They have grown large without compromising process or philosophy.

The last word

For investors, the numbers leave little room for illusion. Scale has advantages – lower costs, operational stability and institutional continuity – but these are defensive strengths. They prevent failure; they do not guarantee outperformance.

In liquid markets, large funds can use their breadth to good effect, delivering stable returns with less volatility. But in less liquid categories, growth in size often marks the beginning of diminishing flexibility and, eventually, diminishing returns.

The appeal of big funds is psychological as much as financial. Investors equate popularity with safety, and safety with reliability. Yet in markets, the comfortable choice is rarely the most rewarding one. Size ensures survival; it does not assure success.

The takeaway is clear. In mutual funds, scale reflects the past, not the future. A large fund is proof that it once performed well enough to attract money, not that it will continue to do so.

Chasing the biggest names may feel prudent, but the better strategy is to look for consistency over capacity and discipline over dominance. Big funds can provide peace of mind, but it is the process-driven ones – large or small – that deliver peace of results.

Size isn’t the same as skill

The biggest funds may look safe, but history shows they rarely stay the best.

Value Research Fund Advisor helps you cut through the illusion of scale and zero in on process-driven funds that deliver consistency, not just capacity. Moreover, with Fund Advisor, you can find out which funds deserve your money based on your financial goals, track your portfolio in real time and know when to scale up or down on your mutual fund investments.

Explore Fund Advisor today

Also read: You don't have to invest in the 'top-performing' mutual fund