Don't fall for the bigger-is-better bias

At Value Research, it has long been a fundamental, strongly-held principle that the parentage of a mutual fund does not matter. Call it the investment version of being non-discriminatory on the basis of caste, religion, gender or ethnicity. As long as a fund fits our criteria of being worthy of investment, we do not care whether it comes from the biggest fund house in the world or from a tiny Indian AMC, which is the youngest in the field.

Unlike discrimination between human beings, which is principally wrong, our non-discriminatory attitude towards small and disadvantaged AMCs is entirely driven by practical experience. There is simply no disadvantage to investing in a fund from a smaller AMC as long as it fits all other investment criteria. In our star ratings, we do not see any connection between ratings and AMC size. The correlation between average rating and AMC assets under management is a statistically insignificant 0.03. Therefore, we can say with confidence that funds from smaller AMCs are no less likely to perform well than those from larger or older ones.

Suggested read: Of small and big AMCs, which one is better?

However, this is not a universal view. Most investment advisors and analysts systematically ignore smaller fund houses. I've seen plenty of analyses and advice documents, newsletters and even media reports which explicitly state this. They just start by saying that they consider only funds above X crore or only the top five AMCs or only AMCs that manage more than X crore. They never explain the logic behind this. Investors read such statements and build a bias in their minds against smaller AMCs. Now, the funds' regulator, SEBI, has also got into the act and practically declared that smaller AMCs are 'non-serious'.

None of this is true. Barring the regulator's views, the rest of them are biased because of two reasons. One is our natural bias in favour of larger providers for all goods and services, as in 'Uber must be better/safer than the local taxi' or 'McDonald's food must be better than that of a local restaurant' and so on. People feel that big companies are better. This may actually be true in some businesses, but it has no basis in mutual funds. This is a closely regulated industry, and all AMCs have to conform to the same standards of propriety, legality and transparency in their businesses. Unlike some other industries, this is not just theory but has been empirically proven over two decades now.

The other reason for this bigger-is-better bias is commercial. Advisors and distributors simply make more money out of larger fund houses. And when you are selling funds, the size argument is a good weapon against good funds from smaller AMCs. Since there are plenty of good funds from the smaller ones, salesmen of larger fund houses can use the size argument to narrow the field. Also, in absolute numbers, there are more good funds from the larger ones simply because they have more funds to begin with. This can give an illusion that larger AMCs are better. This is true even of Value Research ratings.

In the end, investors are losers because they narrow the field by not considering good funds from smaller fund houses.

Also read: Size doesn't matter, mostly