Does AUM Size Matter?

Investors generally focus on a fund’s past returns. They think that a larger fund is better. On the flip side, some investors raise concerns about whether a fund can sustain its strong performance after growing to a substantial size. What is the reality? Rakesh Deshmukh takes a closer look at the scenario

Does size matter? Let’s consider a scenario when someone goes to a shop to buy a shirt. Would the customer choose a small size, a perfect size, or an oversized shirt? Well, it depends on the customer’s preference and taste, right? They may opt for any of these options if they feel comfortable with them. The question may arise: Does only the brand name matter, even if the size is not perfect? Would you purchase a shirt even if the size doesn’t make you comfortable, just because it belongs to your favourite brand? You would not! That’s because it would be of no use if you bought it and it doesn’t fit or suit you. 

Now, taken in the investment context, let us explore the main dilemma of whether AUM size matters. AUM stands for assets under management. It is a financial metric that represents the total market value of all the assets that a financial institution, investment company, or fund manages on behalf of its clients or investors at a specific point in time. AUM includes a variety of assets such as stocks, bonds, cash, and other investment instruments. This metric is often used to assess the size and scale of an investment management business and can be a key factor considered by investors when evaluating funds or financial service providers. 

Does Size Matter?
Every fund, when it is launched for the first time, is referred to as an NFO, which stands for new fund offer. In the beginning, it starts with a very small AUM size (not necessary always) but as the public starts recognising and investing in that fund, the AUM begins to grow. The reasons for this growth can vary. It could be because the fund aligns with the current trend, such as Small-Cap funds being popular at the moment. This may lead to consistent inflows on a month to month basis and the fund starts to perform well compared to its peers. 

It might also be because it belongs to a reputable fund house, has a proven fund manager, or is perhaps influenced by market euphoria. We have three main types of funds: equity funds, Debt Funds and hybrids. A large part of retail investors deal with equity funds, and so we shall focus on equity funds only. Within equity funds, there are different categories such as Large-Cap, Mid-Cap and small-cap funds. Let’s begin by analysing whether the size of these funds really makes a difference. 

Data Pointers
We conducted two analyses using mutual fund data. In the first analysis, we categorised funds based on AUM size below ₹1,000 crore, between ₹1,001 crore to ₹5,000 crore, ₹5,001 crore to ₹15,000 crore and ₹15,001 crore and above. The interesting finding is that in the large-cap category, funds with an AUM below ₹1,000 crore have outperformed others for the majority of the timeframe, as depicted in the chart below. In the mid-cap segment, funds with AUM sizes between ₹1,000 crore to ₹5,000 crore have shown superior performance in a majority of the timeframe. However, in the small-cap segment, the trend is reversed, with funds having large AUMs over ₹15,000 crore outperforming smaller size AUM funds for the majority of the timeframe. 

Let’s move on to our second analysis, where we added the inception date and the AUM growth since its inception. We aimed to assess the relationship between the AUM growth of the funds over a period of time since the inception date and their historical performance compared to funds that have not experienced growth in their AUM since inception. For this analysis, we separated the funds into two categories. In the first category, we calculated the average return of those funds that registered good AUM growth since inception, especially compared to their competitors that started the funds more or less in the same month or year. In the second category, we placed the funds with low AUM growth compared to their peers. 

For this analysis, we would like to start with the small-cap category, which accurately portrays the situation without any exceptions in this segment of analysis. Funds that have experienced significant growth in their AUM have outperformed other funds that have not garnered substantial AUM growth. Alternatively, it can be stated that these funds have begun to demonstrate their performance, attracting investor attention. As investors observed the returns, they shifted their investments from underperforming funds to those exhibiting better performance, and hence the AUM grew substantially. 

In the mid-cap segment, the results are mixed, with some exceptions highlighted by the orange bars. These orange bars represent funds with low AUM growth that outperformed funds with good AUM growth in some timeframes, while in the remaining periods, funds with substantial AUM growth tended to outperform others. In the large-cap category, for the majority of the timeframes, funds with substantial AUM growth have outperformed other funds in comparison to those with less AUM growth as shown in the chart alongside. Thus, it is good to opt for funds with substantial AUM growth since inception rather than those with little to no growth. 

Challenges Linked to AUM Size
Starting with large-cap funds, the size of the funds doesn’t have a significant impact in this category. These funds invest in well-established companies that usually have good liquidity in their shares. However, actively managed large-cap funds sometimes struggle to outperform the benchmark returns. In such cases, one might consider investing in index funds, as for example, Nifty 50 index funds, to get exposure to the market. In mid-cap and small-cap funds, having a larger AUM size can be a concern. First, it becomes a challenge to find regular investment opportunities. Secondly, there’s an issue with liquidity. For instance, if a fund has a capital of ₹500 crore and wants to invest 5 per cent in a company with a market capitalisation of ₹500 crore, it can easily invest ₹25 crore and sell without much trouble. However, if the AUM size is ₹5,000 crore and 5 per cent is ₹250 crore, buying and selling stocks of the company might become a concern due to the larger amount involved and the liquidity issue with these small and mid-sized companies. Funds with large AUM encounter challenges in identifying interesting ideas or good investment opportunities within the same space. 

This is why sometimes some funds put an embargo when there is excessive inflow in a particular segment and less opportunity available in the market. On the contrary, funds with smaller sizes in any category may face challenges too. If they come across a better opportunity, they might not be able to fully take advantage of it due to limited funds. This could potentially lead to compromises in the returns generated. Moreover, buying and selling shares with limited capital incurs costs, and fund managers need to be diligent in managing expenses to enhance performance since the net asset value (NAV), which represents the fund’s value, is calculated after deducting expenses. 

Another challenge faced by fund managers with a small AUM size is when many investors redeem their funds frequently or all at once. In such situations, fund managers may be compelled to sell off their good or liquid positions to meet the redemption requirements. However, it’s important to note that this circumstance doesn’t automatically imply that funds with a larger AUM are better compared to smaller ones. Each size category comes with its own set of challenges and considerations. 

Conclusion
To conclude, it really comes down to the fund house and the manager managing the funds. Some smaller funds do exceptionally well, attracting a good number of investors and growing significantly over time. It’s important to note that many funds started off small and became large because people noticed their performance, and investors possibly redirected their money into those funds. So, when investing, it’s a good idea to choose funds and fund companies that have a decent size and maintain high professional standards. Briefly put, there is no proper formula or thumb rule for defining the correct AUM size. 

AUM is a good way to see how popular and successful a fund is (since more money comes in when the fund is doing well), but it shouldn’t be the only thing you look at when choosing mutual funds. Before you think about AUM, make sure to also consider the fund’s past performance, how consistent it has been, its ability to handle both ups and downs, the skills of the fund manager, the fund’s goals and strategies, the reputation and methods of the fund company, and the costs involved.