Will size of fund impact its performance?

What should you be looking at when you are selecting a mutual fund?  Should one be checking the size of the asset under management (AUM) before investing in a fund? These are some of the common queries. To throw more light personal finance expert Hemant Rustagi, Wiseinvest Advisors spoke to CNBC-TV18

He believes a fund can become unwieldy to manage if it grows too large but the impact of the fund size on the performance will clearly depend on various factors like the asset class it is investing in and the investment strategy and philosophy of the fund. For a fund that predominantly invests in large cap stocks, there is no negative impact because of the size of the fund because the fund manager has no problem buying and selling stocks of any quantity at any given point of time, explains Rustagi.  Even for debt funds like liquid funds or ultra short-term funds, short-term fund or income funds; the size of the fund will not impact the performance unless the fund outgrows its investment style, he asserts. Also some funds like value fund, sector fund, midcap funds, thematic funds, can get negatively impacted if the fund becomes too large. An investor, before investing in a fund needs to focus on the quality of the fund portfolio and how the fund has been doing vis-à-vis its benchmark as well as the peer group, he advises. Also read: SBI Mutual Fund says the mutual fund’s midcap style of investing is bottom-up. Below is the edited transcript of his interview on CNBC-TV18 Q: Do you believe smaller funds have the capability to outperform because their mandate is smaller and they could invest in smaller stocks which tend to give you higher beta higher returns? A: A fund can become unwieldy to manage if it grows too large. We need to  understand that the impact of the fund size on the performance will clearly depend on different factors like the asset class the fund is investing in and its investment strategy and philosophy. If you look a fund which invests predominantly in the large cap stocks; the size of the fund will not impact the returns negatively at all. That is because the fund manager will have no problem in buying and selling stocks in any quantity at any given point in time. If you look at the debt funds like liquid funds or ultra short-term funds, short-term fund or even income funds, the size of the fund will not impact the performance. But if the fund outgrows its investment style then it can make a difference. For example if you look at a midcap fund, the major differentiator between a good performing fund and a poor performing fund in midcap category is the stock picking ability of the fund manager. If the fund becomes too large, the chances are that the fund manager might be compelled to compromise on the quality of the portfolio or the liquidity in the portfolio. As we know that this segment of the market remains under research and there aren’t too many opportunities here. The fact remains that these companies have the potential to do well over a long period of time and these funds do attract large sums of money especially when the markets are doing very well. In a way they become victim of their own success. If it's a midcap fund then the size will definitely make a difference. Also if it happens to be a sector fund and fund becomes too large, then the fund manager may actually struggle to find good quality stocks in the portfolio. The fund size can have impact on the fund but that clearly depends on the asset class it is investing in and also the investment style of the fund. Q: Is this the way to go about when you are choosing a mutual fund, that is you just go to one of these mutual fund's online websites and check out 90 day performance, one-two year performance? The fund that has consistently higher return is the one to go for?
A: Performance is definitely one of the key parameters but it can not be the sole criteria for investing in a fund. Especially when you are looking at performance one has to look at a longer performance. Especially so in equity funds, you need to look at three-five years or even more. If you go to the mutual fund website and there are also other portals where information is available for the fund performance for the last seven-ten years, fifteen years. 
One needs to look at how consistent the fund has been in terms of performance. The key factor is also the suitability. Investors need to make sure that the funds they are investing in should be suited to their investment goals and their risk profile. Thereafter, in some category of fund, the size of fund should be looked at and investor needs to keep an eye on that. For rest of the funds the consistence in performance and the suitability are major factors to decide. Caller Q: Many people are advising well performing funds like HDFC Top 200 Fund, its current net asset value (NAV) is more than Rs 220. My question is that like in equity sometimes when the stock prices have run up too much, expert say their valuations are too expensive, is there such a concept for mutual fund also or can NAVs of mutual fund keeps increasing infinitely? A: It is always good to invest in a fund that has done well over a longer period because when we talk about considering a fund which has a good performance track record over a longer period, it basically confirms that the fund has the ability to perform in different market conditions. As an investor we need to understand that there are two options in a fund. We have growth option and dividend payout option. The dividend payout will continue to pay dividend periodically, maybe once in a year or sometime twice in a year. In the growth option, the NAV of a fund will continue to grow and become high over a period of time. Basically, it reflects the compounding effect of growth in a fund. As an investor, it is very important for you to understand that it is the quality of the portfolio, or its investment strategy, which matters and not the NAV because the NAV can become high over a period of time. In fact investing in equity funds is akin to investing in stocks. When you invest directly into the stock, obviously you need to track valuation looking at price to earning (P/E) or price to book or various other factors. The fund manager does exactly the same on your behalf when you invest in a mutual fund. He keeps making decision in terms of exiting from particular stocks or investing in them or holding them on for a longer period. The parameters which are applicable for investing in the stocks are also applicable in the mutual fund but the key differentiator with regards to MFs is that all the decisions in this regard are made by the fund manager, on thei investors behalf. So, what matters is the quality of the portfolio. All the decisions that a fund manager takes, reflects in the performance. If your fund is performing well, vis-à-vis the benchmark, as well as its peer group then we need not worry about the NAV level. Infact the right way to look at higher NAV is to look at the reflection of compounding effect on the NAV over a period of time.