Investing in mutual funds: Why small is beautiful

Experts say you may invest in small-sized funds and benefit from their nimbleness, says Sanjay Kumar Singh.
Illustration: Dominic Xavier/Rediff.com

Is big always beautiful? Not necessarily so in the mutual fund industry.

While big fund houses with their strong distribution reach and multiple schemes to match all kind of investors' needs are able to garner most of the money, several smaller fund houses have small schemes with assets of less than Rs 1,000 crore that deliver steady returns to investors.

Funds from fund houses like Quantum Long Term Equity and PPFAS Long Term Value are examples.

Many investors, however, are afraid to invest in these funds because of their small size. Experts say that provided you avoid the minuscule-sized ones, you may invest in small-sized funds and in fact benefit from their nimbleness.

Small means agile

A small-sized fund is nimble and agile.

If a fund has an AUM (assets under management) of Rs 500 crore and wants to invest five per cent of its corpus in a stock, that is only Rs 25 crore.

The fund can deploy the money quickly.

"With small size it becomes easier to time your calls. Real active management is much more possible when your asset size is not very large," says Vidya Bala, head of research, Fundsindia.com.

Consider the converse situation, where a fund has an AUM of Rs 15,000 crore.

Even one per cent of Rs 15,000 crore is Rs 150 crore.

Such a fund will have to let go of many stock ideas because they are too small for it.

Those stocks may not have the required liquidity for the fund manager to be able to deploy enough money in them.

If s/he does buy a stock with low liquidity, the impact cost (price getting driven up due to the fund's purchases, increasing its average cost of acquisition) will be high.

This is especially an issue in the mid- and small-cap segment (not so much in the large and multi-cap space).

A big fund also needs many more stock ideas. Such a fund may become too large to deploy all its money in the fund manager's 25 best ideas.

The manager may hence be forced to invest in ideas that are not as compelling.

Moreover, if a fund manager has to invest in a large number of stocks, tracking them all becomes difficult.

This problem of asset bloat could result in muted performance.

Myths about small size

Investors harbour many fears about small-sized funds from smaller fund houses.

While these issues do exist, one needs to see if they are exclusive to small fund houses.

One fear is that a small fund house could get taken over.

As Rajeev Thakkar, director and chief investment officer at PPFAS Mutual Fund, says: "The issue of viability has been there across size. Many financial powerhouses like JPMorgan, Fidelity, Goldman Sachs, Morgan Stanley, etc set up fund houses in India and then exited after a few years as they couldn't make the business viable."

At the same time, a fund house like Quantum (AUM Rs 1,012 crore) continues to thrive since 2006.

Investors also fear that a fund manager who has proved her/his mettle at a smaller fund house might get poached by a larger fund house. Again, this is not borne out entirely by facts.

Fund managers at smaller fund houses might move to bigger ones, but the reverse also happens.

In recent times, while Vetri Subramanian (from Invesco to UTI Mutual Fund) moved from a smaller fund house to a bigger one, there has also been movement in the reverse direction, with Anoop Bhaskar (from UTI MF to IDFC MF) and Kenneth Andrade shifting to smaller outfits (the latter from IDFC MF to setting up his own PMS firm, Old Bridge Capital Management).

Investors also fear that in a small-sized fund any redemption pressure could force the manager to sell some of the better stocks in the portfolio. This could hurt future performance and be detrimental to investors who have not exited.

"That is more of a fear in debt funds, like liquid and ultra-short term categories, where large institutional investors predominate. In equity funds, you usually have a large number of retail (individual) investors," says Bala.

Redemption pressure is likely to arise in an equity fund only in case of a steep market correction. Hence, Fundsindia.com has a minimum AUM criterion of Rs 200 crore for the large-cap funds and Rs 100 crore for the mid- and small-cap funds it recommends. You, too, could follow this rule.

Performance doesn't always lead to bigger AUM

Sometimes, a fund's AUM remains small despite sound performance due to extraneous factors.

Take the case of Motilal Oswal MOSt Focused 25, a large-cap fund that has given a return of 18.55 per cent over the past three years, beating its benchmark by 7.63 percentage points.

The same fund house's midcap fund, Motilal Oswal MOSt Focused Midcap 30, has given a return of 31.07 per cent, beating its benchmark by 5.08 percentage points.

The large-cap fund has so far managed to garner an AUM of Rs 478.6 crore, while its midcap cousin has an AUM of Rs 1,256 crore.

"Particular types of funds do well in particular periods. Money flows to the segment of the market where returns are higher, while other segments get ignored. In this case, though our large-cap fund has also done well, it has not managed to gather much AUM because a particular style is doing better and is attracting most of the inflows," says Siddharth Bothra, senior vice-president and fund manager, Motilal Oswal Mutual Fund.

If a fund's size is small because of such factors, one should not fear investing in it.

Finally, a fund house has many expenses, such as the fund management team's salary, providing the team with research tools such as Bloomberg, allowing analysts to travel and meet sources, etc.

All this makes it essential that a fund house should have a minimum corpus to be able to pay for these.

If it doesn't, it could lead to compromises on quality of work.

Experts, however, say it is hard to stipulate a minimum AUM size a fund house should have. So long as a small fund house runs a limited number of schemes, it may do a good job.

"If a small fund house is focused on the task of asset management, and has good risk management systems, good processes, and a good team, we don't mind its small size," says Amar Pandit, founder and chief executive officer, My Financial Advisor.

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