Moneycontrol » News » Mutual Funds » Advice

Does a fund�s size impact its future performance?

Published on Thu, Feb 07, 2008 at 11:38 | Source : Moneycontrol.com

Updated at Thu, Feb 07, 2008 at 12:50

Like this story, share it with millions of investors on M3

Share on Tumblr

RELATED NEWS

There are various parameters on which a particular mutual fund may be evaluated to ascertain its' investment worthiness. These include the past performance, expense ratio, the fund's PE ratio, its' top 5/10 holdings, Sharpe ratio, standard deviation, the fund manager, etc.

Amongst these parameters, there is one more criteria i.e. the fund's corpus size. Does a fund's size have a bearing on its' future performance?

Is there an optimal fund size?

One obvious benefit of a larger fund size is the reduction in the average costs. As the size of a small fund increases, it may see appreciable reduction in the average fund management expenses. Though of course, beyond a point, any further increase in size may not have the same impact on costs.

However, a small fund say of about Rs.100-150 crore may be more flexible and nimble. Such a fund could get in and get out of stocks easily and without disturbing/distorting the market. But it may not be able to achieve adequate and suitable diversification levels. The relatively concentrated portfolio of a small fund increases the risk.

On the contrary too large a fund say around Rs.4000-5000 crore may distort the market prices especially when investing in small companies. Secondly it may also become over-diversified. A fund may not like to take more than 5-10% exposure in a single company. Therefore, to deploy a large corpus it would have to build a large portfolio say having 50-70 companies. This would particularly be a problem if it is a sector/mid-cap oriented fund, wherein either the investment universe is small or the market-capitalization of companies is small. A large portfolio not only becomes difficult to manage, but the returns are also likely to be diluted.

Also, as management fees are a function of the corpus size, with the same % a larger fund could pay higher fees and attract better talent than a smaller fund.

Therefore, from the point of view of both the average costs and proper diversification, it stands to reason that there is possibly some optimal fund size.

Of course, there cannot be a mathematical formula or a thumb rule, as to what this optimal size could be, because size is not the only determining factor in a fund's performance. Its' investing style, fund manager's expertise, investment opportunities, research capabilities, etc. also have a major role to play in a fund's performance.

What do the past trends indicate?

Popularity of some mid-cap funds saw huge inflows in such funds. However, except for Reliance Growth, others were not able to maintain the same level of performance. (In fact, Reliance Growth and Franklin Prima did stop accepting fresh purchases for some period of time, as the investment opportunities in the mid-cap space are limited.) Vis-�-vis this, some of the mid-sized mid-cap funds were able to perform much better than the established large peers. This, of course, is a one small example.

In order to cover a broader canvas, funds with more than 3 years of performance history were segregated into 2 groups - one with corpus size less than Rs.100 crore and the other more than Rs.100 crore. Then the average returns over 1 month, 6 months, 1 year, 3 years and 5 years were compared as at different times such as Nov 06, Jan 07, Mar 07, May 07, Oct 07, Dec 07 etc.

Out of 30 such observations, only once did the small fund category give better returns. Otherwise, 29 times the large fund category delivered better returns. On an average they were about 7% higher.

However, caution is advised. The above is just the comparison of averages. This means that there are some small funds, which have outperformed many large funds. But as mentioned earlier also, this may not be purely due to the fund's size.

From the aforesaid observations one could therefore conclude that the fund's corpus size does have a role to play as to how it may perform in the future. Therefore, some analysis of the fund's size becomes necessary.

The size of the fund should not be disproportionately large as compared to the available investment opportunities in its' focus segment. For example a small thematic fund has the higher probability of better performance than a large thematic fund.
A medium sized fund may perform better than say too small or too large a fund.
If the cash holding is high because the fund manager cannot find appropriate investment choices, then such a fund may have crossed its' optimal size.

This kind of enquiry could help in choosing the right-sized funds amongst the many choices available.

- Sanjay Matai

The author is an investment advisor and can be reached at sanjay.matai@moneycontrol.com.

For more Views by Experts click here