I plan to invest in mutual funds for the first time. Should I go for a big fund or a small fund? James Mathew, via e-mail
No doubt, the size of a mutual fund is an indicator of its popularity among investors. However, this in any way does not reflect that a large fund will deliver better returns or a small fund will be a lousy performer. And returns are one of the most important things you would look for in a mutual fund or any other financial instrument.
The size of a fund or its asset base represents the market value of the fund's investments on a particular day. Since the value of investments—whether stocks or bonds—fluctuates everyday, so does the asset base or the size of fund. Investors leaving and entering a fund can also affect the asset base of a fund.
If we look at size in the context of equity funds, it can be said that smaller funds can be more agile. They can easily buy and sell and the impact cost associated with these transactions would be minimal, if at all. But small size can also be a hindrance. Lack of sufficient assets may not allow a fund to achieve a greater level of diversification. In the case of index funds, size may be an asset. Any inflow can be easily invested without giving rise to significant tracking error. In the case of a small index fund, the same inflow may look substantial and it may not be easy to allocate it without causing a tracking error.
For debt funds, size becomes a critical factor because of the effect of expenses. Larger funds can distribute fixed expenses over a number of investors. This can bring down the expense ratio and thus reduce its impact on fund returns. Larger funds can also negotiate better rates with issuers of debt papers.
In the case of all these observations there will be exceptions also. So size does have a role to play, but not when it comes to deciding which fund to buy or sell.
This article was originally published on April 07, 2003.
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