What is AUM and should you check it before investing?

Let's understand if AUM can impact your mutual fund returns

AUM mutual fund: Should you look at AUM before investing?

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Mutual funds invest in equities, bonds, and other such instruments. If you add the market value of all the investments made by the mutual fund along with any idle cash that it holds, the final tally is called AUM - short for asset under management. In other words, the AUM tells you how large or small a particular mutual fund is.

AUM can increase/decrease in two ways; one is when more people invest or exit the fund and the other is when the mutual fund's investments rise or fall in market value.

Going by this logic, the top-performing mutual funds in India and globally tend to attract more investors and grow bigger in size. Hence, some investors conclude that a bigger fund is better as it will continue to do well for two reasons:

  • A larger AUM fund or fund house can get better services in the industry and spend more on strengthening research, which works in favour of investors.
  • The expense ratio of larger mutual funds tends to be lower as compared to funds with smaller AUM.

The doubters, on the other hand, feel funds that are growing in AUM have become too big and may either fail to sustain their performance or have limited space to grow more. Also, since these funds work with smaller amounts of money, they can face liquidity-related issues during mass redemption.

So, a question that baffles many investors is which funds are better, the larger ones or those that have a lower AUM? The short answer is - it depends. Yes, we know this does not explain much. So, read on!

If a mutual fund invests in large-cap stocks
For funds investing predominantly in large-cap stocks (large companies), its size is not really a matter of concern. These funds invest in big companies that are actively traded. So, liquidity is not a problem here.

If a mutual fund invests in small-cap stocks
Here, it may be easier for a small-sized mutual fund to invest in small-cap stocks.

Let's give you an example. Say, a company that falls under the small-cap stock category is worth Rs 1,000 to Rs 1,500 crore. So, when a smaller fund with an AUM of Rs 100 to Rs 200 crore plans to invest 5 per cent of its money in that company, it can go ahead and do so because the investment money is not very large.

However, if a large-sized mutual fund with an AUM of Rs 5,000 crore plans to invest 5 per cent of its money in that company, it may not be possible because of the investment size.

And even if it is possible, it may have to incur an 'impact cost', where the fund's trading activities can significantly move the stock price. Also, it may not be easy for the fund to sell such a large investment if they plan to exit the investment at short notice.

Moreover, since it's not very practical for large funds to invest a sizeable percentage in small-cap stocks, they may need to find more buy-worthy stocks. But finding a quality unspotted small-cap company is not easy.

How big is too big?
There is no mathematical formula to determine at what point the size of the fund becomes too big. But as long as the fund manager is able to continue the investment strategy of the fund, it is fine.

Do keep in mind
The ability of the fund manager, AMC's track record and the strategy of the fund matter more than the size of the mutual fund. A top-performing mutual fund is one that consistently performs well across different market cycles.

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