Does AUM size matter while investing in mutual funds?

Here are a few tips which describe whether AUM size matter while investing in mutual funds or not:

Does AUM size matter while investing in mutual funds?

Many times this question has surfaced at investment forums that “Does fund size affect fund performance?”

Size of a mutual fund scheme is reflected in Assets under Management (AUM).

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AUM relates to the total market value of all the securities held by the asset management company (AMC) on behalf of the investors.

The value of AUM keeps fluctuating daily. The fund size is influenced by market movements and fund inflows/outflows. Notably, in case of open-ended funds, AUM expands when new clients invest in the scheme and when the market value of assets increases.

Conversely, AUM shrinks when existing investors leave the scheme via redemption, and when the market value of assets decreases. Ultimately, the success of a mutual fund scheme depends upon the judicious use of AUM by the fund manager.

Efficient use of AUM via robust investment strategy determines the overall strengths and weaknesses of the AMC. With the help of AUM, investors get an idea about the size of AMC vis-à-vis its competitors.

Investors believe that there is a link between the size of the fund and its performance. They feel that the larger the fund size, the higher are the funds at fund manager’s disposal.

Hence, he would be in a better position to take strategic calls; leading to better fund returns.

However, analysts haven’t found any concrete relationship between AUM and fund performance. In spite of that, you may use AUM to select appropriate mutual funds that have higher growth potential.

Also read: How to select a good mutual fund that suits you

Ideal fund size: Too big or too small

As regards AUM, there cannot be a one-size-fits-all approach.

You cannot estimate precisely the figure which represents an ideal fund size. You would have to draw comparisons within the fund category to identify the appropriate mutual fund scheme.

However, the point at which the positive relationship between fund size and management efficiency becomes inverse can be called the unsuitable fund size.

In other words, inappropriate fund size is one in which the adverse effects of the AUM offsets the positive effects of a fund’s total returns performance.

Let’s understand this with the help of an illustration.

Consider a case wherein a newly introduced equity fund becomes so prevalent as to attract a large number of subscriptions. The fund size in this situation might grow to such an extent that it becomes difficult for the fund manager to get a hold of it.

In other words, at this point the fund manager finds it challenging to maintain the fund’s investment strategy and produce returns in line with the historical record of the scheme.

Thus, to deploy the excess funds, the fund manager might have to invest in assets which do not conform to the investment mandate.

If this continues for an extended period, then the fund might start resembling the asset allocation of an index fund. In such a situation, you would be better off investing in a low-cost index fund instead of paying a higher cost for an active fund which mimics index fund returns.

Now imagine an opposite situation in which the fund size too small.

When AUM of a fund is relatively smaller than its peers, it may create vulnerabilities. It is evident especially during a slump in the market.

A large number of investors might exit from the fund considering the continuous erosion in the returns. A substantial outflow of money in this way might put the remaining investors’ stakes at risk.

Fund Size and Fund Category: The critical relationship

The fund category also dictates the appropriate fund size. The fund size that is ideal for a large-cap equity fund would be different from that of a small-cap fund.

A small-cap fund would be more effective in its initial strategy with a smaller fund size compared to a more extensive fund size. It’s because the small-cap fund is composed of few thinly traded stocks.

So, in the event of adverse price movement, it would be easier to liquidate a position of Rs 3 crore as compared to a stake of Rs 300 crore.

On the other hand, in case of larger fund size, the fund manager might be unable to liquidate the position quickly leading to massive losses.

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But larger fund sizes are not all that bad; especially in case of index funds and bond funds.

In both these cases, a larger fund size is better than a smaller fund size on two counts.

Firstly, portfolio management is easily handled because it doesn’t require as frequent trading as an active fund.

Secondly, the operating expenses of the fund are distributed over a broader asset base thereby reducing expense ratio of the fund.

How to take fund decisions based on asset size?

The dynamics of the fund size can provide you cues to take informed fund decisions as follows:

Does AUM size matter while investing in mutual funds?

Fund size in the context of investment style

You can examine the fund size in the light of fund category and investment style. Compare the fund size of your scheme with that of peers. Choose the one that’s relatively neither too big nor too small compared to peers.

Moreover, try to find out whether the fund is following its investment mandate religiously or not. It would ultimately impact your risk profile.

Continuous contraction of fund size

While choosing a fund, you need to scrutinise holistically. Suppose upon comparing the fund size to historical records; you find that there’s a constant decline in the asset base of the fund.

It points out to an anomaly which has not been taken care of for a long time.

In yet another situation, you are already holding units of a fund that is showing continuous exits and redemptions.

In both these cases, it’s better to avoid investing in the fund. There’s no good in catching a falling knife.

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Funds with huge cash positions

It is usual for the fund manager to hold a few cash positions to meet any requests for redemptions. But if he ison significantly large cash positions for quite some time, then it should ring a bell in your mind.

It’s an indication that he’s not finding a good investment which is keeping him from deploying the excess cash.

Thus, you may look for better funds with lower cash holdings to earn higher returns.

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Final Words

While taking your next mutual fund bet, make sure you look into these aspects to arrive at the right one.

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