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Fund size matters less than you would think

Should investors pay attention to the size or AUM of a mutual fund? Read on to find out


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Time and again we come across the question of whether fund size, also called assets under management (AUM), matters. Many investors like to invest in big funds because they feel they are more likely to do well. Is there a grain of truth in this?

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The case of equity funds
In equity funds, AUM is not an important factor to consider while choosing a fund. What is more important is the consistent performance of the fund across market cycles and the ability of the fund manager to deliver good returns despite varying AUM.

This means that you can't pick a random large-size fund and say that just because it's large, it must be good. Similarly, looking just at size, you can't discredit a small fund which has shown good performance.

A large fund size, however, does reflect the popularity of a fund, and is also an indicator of how long it's been around. But its size is certainly no guarantee that it will continue to do well. Past performance does however provide some insight into how well the fund is capable of performing, and this counts for something.

What about small-cap funds?
Small-cap funds are notorious for restricting inflows when they are no longer able to deploy capital. This generally happens when the fund dramatically grows in size. A fund cannot buy big stakes in small companies because if the fund becomes a significant shareholder in the company, it may not be able to sell its stake easily, especially during market falls. Also, large-scale buying in small companies could create 'impact cost', where the fund's buying can significantly move the stock price.

Given the run-up in the small/mid-cap valuations space, it has become increasingly difficult for many fund managers to find investment-worthy stocks within the mid- and small-cap universe. Does it mean size is a constraint in the case of small-cap funds?

Fund houses deploy a host of methods to avoid the asset-size problem in small-cap funds. Some of these are
1. Expanding the investment universe
2. Avoiding lump-sum inflows and sticking to SIPs
3. Keeping a long-term view and building positions slowly
4. Owning large caps for liquidity purposes
For investors, investing through SIPs and keeping a long-term view will help.

The case of debt funds
For debt funds, size becomes a critical factor because of expenses. Large 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. Large funds can also negotiate better rates with issuers of debt. On the other hand, if a large debt fund is faced with huge redemptions, the market may not have adequate depth to bail it out. So, with debt funds, avoid the two extremes.

Depending on the type of fund, therefore, the size can have an impact. In the case of most equity funds, however, it is not as relevant. Fund sizes have not grown to the point where the liquidity of assets is a real problem. As an individual investor, the most important point to bear in mind is that the performance of a fund is more important that its size.

 
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