Fund sizes – Is bigger necessarily better?

It’s the time of the year again and Sam plans to invest his bonus. Finding two funds that have passed his checklist of good consistent track record, credible fund management company, low expenses, he moves on to the next criteria – fund size. This is where the similarities end; one has a much bigger fund size than the other.

Sam is at a lost. Would bigger funds project a more reliable image? Putting yourself in Sam’s shoes, what would you have done? Here are a few considerations that we suggest you to look out for when scrutinising fund sizes:

Fund strategy

First, consider the size of the fund relative to its mandate or strategy. For a fund that specialises in small cap stocks, the fund size should be correspondingly small but enough to achieve adequate diversification across at least 20 to 25 stocks.

Preferably, the fund size should not get too large. Imagine a RM500 million fund trying to establish a five per cent weight into a small cap stock. Although it only means a RM25 million position from the fund’s perspective, consider the amount relative to the market capitalisation of the stock itself.

The RM25 million will be equivalent to a substantial 12.5 per cent stake in a small cap stock with market capitalisation of RM200 million. Not only would the fund manager have problems buying that much into the stock, eventually he would have problems getting out of it as well.

That being said, would a larger fund size befitting for a fund that buys into large caps? It could be due to a specialist mandate or the fund could be restricted into doing that because of its burgeoning size, but here’s some food for thought.

There is a likelihood that the fund’s return could resemble the returns of the index. After all, it will not be easy for a large cap stock to achieve double digit returns. So, in other words, you could potentially be paying an alpha price for a beta performance.

Operating costs

At the same time, a fund that has too little in terms of fund size may potentially face higher Management Expense Ratio or MER. These consist of the costs stemming from the various fees charged: brokerage, audit, trustees, research and so on. A larger fund would be able to achieve better economies of scale and spread out the costs. That is why funds which are persistently too small to be viable are more likely to be eventually liquidated or shut down.

Sudden increase/decrease in size

If possible, check out the size of the particular fund several months or even a year before. If there are any big increases or decreases in size, that should pop up as a warning sign. Contrary to the belief that more money is better, a sudden or rapid inflow of money can cause a few problems.

Here’s a scenario of what could possibly happen. A fund is awarded for a series of good performance and the next thing you know; everybody starts pouring money into that fund. Behind the scenes, the fund manager may not be able to invest the fresh funds straight away hence most of it will be sitting in cash. On the other hand, if the fund made its name specialising in quick and agile decisions in small or mid cap stocks, the massive bulk of funds will neutralise its advantage. Performance will eventually suffer.

Sudden decreases in fund size should also be a red flag. There could be reasons happening behind the scenes that you are not aware of; such as a departure of the fund manager or other uncertainties that are causing investors to yank money away from the fund.

Conclusion

In our opinion, a fund size of between RM20 million to RM30 million for a local equity fund would be considered small. An ideal size for a local equity fund to have adequate diversification, liquidity and cost efficiency would be between RM20 million to RM200 million. Smaller sized funds are also known to be nimbler and more agile than their larger peers.

Before you invest, always do your homework. There can be more ways to judge a fund other than its performance chart or table. Fund sizes are one of the areas that you should keep an eye out for, as we have shown above.

However, let us highlight that there will be exceptions to the rule. A smaller fund may be able to justify a higher MER by producing higher than average returns. Or a fund manager could be adept at managing significantly more money than the investing style would suggest.

Areca Capital is a niche Malaysian fund management and wealth advisory/financial planning company. We are a firm believer in the advisory-based approach towards investing. For any enquiries, contact us at 03-79563111 or by email at invest@ arecacapital.com.

Disclaimer: The article is produced based on material and information compiled from reliable sources at the time of writing. The article is not an offer, recommendation or advice to transact in any investment products, including the stocks or funds mentioned within. Investors are advised to consult professional investment advisers before making any investment decision.