Does size matter for mutual funds?

When funds get successful, they start receiving more money from investors. Therein lies the challenge.

As counterintuitive as it may seem, when funds grow, it becomes trickier for fund managers to find winning stocks and generate alpha. But does this mean an increase in fund size negatively affects the fund's performance on a relative basis? Here's what we found.

Our methodology

We considered the quarterly data of only those funds with three years of information.

To keep things simple, we tested three different categories of funds: large-caps, mid-caps and small-caps.

Our findings

The majority of the funds across all the categories showed either no correlation or low correlation between their relative size and relative performance in the subsequent periods.

Before you look at the data table below, let us explain what we mean by different correlations.

'No correlation ' means the fund has performed well or poorly, irrespective of its size. In other words, the fund's performance doesn't depend on its size.

'Positive correlation' implies that the performance has been good with an increase in size and not so good with the decrease in AUM.

'Negative correlation' indicates the fund has not been able to keep up its performance as it grew in size.

What we found

It is interesting to note the nature of the correlation between the fund size and its performance.

While 42 per cent of large-cap funds, 30 per cent of mid-cap funds, and 24 per cent of small-cap funds showed no correlation, most remaining funds showed low to moderate negative correlation. This means that while most funds did not show any significant fall in their performance as their size grew, they still performed better when they were smaller.

Our take

The correlation between fund size and its performance is weak. A negative or 'no' correlation doesn't mean you shouldn't invest in these funds.

Moreover, if you look at the top-performing funds, you will see that it is a mixed bag of small, medium and large-sized funds.

In fact, this indicates that one should not merely focus on the fund size. There are other factors - such as your investment horizon, ongoing fund performance, expense ratio, age of the fund, and your risk appetite - that should be considered too. It is a mix of all these factors that will help you pick an equity fund best suited for you.

Suggested read: Should you check AUM before investing?

This article was originally published on July 18, 2023.