Is there a correlation between AUM and returns?
- Kembay Venkataramana Rao
Yes, there is a different kind of correlation. The rule is that when AUM goes up i.e. when the fund gets larger, fund companies are supposed to charge lower expenses. So, assuming that there are two funds that generate the same kind of return from their respective portfolios, the larger fund will get you a higher return simply because it has to charge less. For example, if there are two funds, one is a Rs.5000-crore fund and the other is a Rs.20000-crore fund. The Rs.5000-crore fund generating 10 per cent returns will charge a higher expense, while the Rs.20000-crore fund generating 10 per cent returns will charge a lower expense. Hence, after accounting for expenses, returns would be higher in the second case. Particularly, in the case of debt funds, the larger fund gets more competitive and sometimes charges less, because of the competitive pressure. So, I would say that this relationship is due to the expense factor. And that's one kind of correlation.
The other is the manoeuvrability, flexibility and its ability to demonstrate performance based on the freedom of strategy. So, think of a multi-cap fund. Multi-cap funds recently came into trouble because of the regulatory move that every fund in the category is mandated to invest 25 per cent each in small cap and mid cap as well. The move was entirely driven by the fact that when multi-cap funds succeeded, most of them got so much money that it did not make sense for them to be investing in small caps. But if it remained a small-sized fund, then it was possible for it to do whatever it wanted to.
My sense is that a big fund will be deprived of many stock investing opportunities simply because it has turned big and making a small investment in a compelling company also will not have a meaningful impact on its overall performance. So, I think that a relatively smaller fund is more manoeuvrable. We have seen that some of the smaller funds, which have existed in the past and have done exceedingly well, did very well when they were small but they turned out to be not so impressive when they turned big. So, for equity funds, big is bad.
There is also a theory popularly called 'The Winner's Curse'. When a fund does well, more people put money. When more people put money, it gets very difficult to replicate the strategy that the fund followed in the past or the kind of thing that it did in the past because the bigger size becomes an impediment. So, I would say that there could be different thresholds. For example, my sense is that a small-cap fund more than Rs 2000 crore could be big. For a mid-cap fund, a size of more than Rs 5000 crore could be big and for multi-cap, a Rs 15000-crore fund could be considered big.
In the case of index funds, the bigger, the better because the fund does not require great effort. Larger funds would tend to have lower expenses, thus translating into superior returns for you.
This, I believe, is going to be one of the biggest problems which is leading to disenchantment or disappointment of investors in mutual funds. This is one thing that is actually at odds where on the one hand, the fund companies make money when they manage more money and on the other hand, you make more money when the fund is small and it does much better. You would like your 10 rupee becoming 50, but a fund company also gets new investors who put in money to make it even bigger and in the process, fund houses make even more money. So, these two goals are going to be at loggerheads and this is going to be a serious problem.