MFs: Size doesn't matter

"Thank you investors; our AUM (assets under management) have crossed Rs 70 billion." Tall claims like this one are quite common in the world of mutual funds. A higher asset size is often flaunted and perceived as being indicative of a superior fund.

Is this assessment accurate? Does a larger AUM size mean that the fund is a superior one? Not necessarily!

A host of factors ranging from returns to management style, amongst others contribute towards making a better-quality fund.

While there is no denying the fact that investors are likely to be driven towards funds which perform well, which in turn will contribute towards building a sizeable corpus, a larger asset size can also be the result of an aggressive sales pitch.

Let's consider how some of the top-performing diversified equity funds 'perform' on the asset size front.

The bigger, the better?

LIC MF Growth Fund (102.98%) with an asset size of just over Rs 140 m manages to outperform giants like IL&FS Growth & Value Fund (100.88%) and Franklin India Prima Fund (100.11%).

The smaller asset size did not deter the fund from delivering impressive results. There is no pattern to suggest that funds with larger corpuses have delivered better results or otherwise.

One can safely conclude that there is no correlation between the fund's asset size and its performance. If investment decisions were to be based on the fund's asset size, it could prove to be the investor's undoing.

Now let's see if a higher asset size has helped mutual fund schemes reduce their expenses. With a larger corpus at their disposal funds should be able to benefit from economies of scale (the fund doesn't need more fund managers just because it manages a larger corpus).

While the argument sounds right theoretically, in practice it is seen more as an exception rather than a rule. A large sized fund like Reliance Growth Fund with a corpus of Rs 5,374 m has the same expense ratio as a smaller fund like LIC MF Growth Fund (asset size Rs 141 million).

Expenses eat into the returns generated by the fund offered by the fund and are of vital importance for investors.

A well managed fund should be able to successfully curb volatility. Let's find out if having a larger corpus helps in keeping volatility at bay. While the highest standard deviation figures are for a smaller sized fund i.e. Tata Equity Opportunities (10.01%), larger funds like Franklin India Prima Fund (9.54%) haven't helped their investors' cause either.

Yet again there is no sequence prevalent which suggests that investing in a larger fund can prove to be beneficial for investors.

Having dispelled the myth that a mutual fund with a larger asset size is equivalent to a good investment decision, now let's concentrate on the positives of a smaller fund.

Smaller funds tend to be nimbler, which enables them to easily take positions or shuffle the stocks in their portfolio.

For example an Rs 500 m fund can easily offload Rs 50 million (10% of its net assets) without having any significant impact on the markets. The same may not be possible for an Rs 5 billion fund.

The fund manager might be forced to offload the stock over a few days so as to deaden the impact on his portfolio.

Does this mean all large funds are necessarily bad? Not really. Larger funds (perceived as being prestigious) are often in a position to offer attractive remuneration and can attract the best of talent i.e. fund managers and analysts.

Again certain instruments like government securities (gilts) and bonds are bought and sold in large lots. Fund managers can negotiate better deals by swapping larger lots.

While both large- and small-sized funds have their advantages, the size per se is irrelevant. Pick a fund based on its management style, objective, returns and expense ratio amongst others and not its size. This is one area where size doesn't matter!

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