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Fund Selection Criteria – Size & Stability

Introduction

One of the first things an investor looks at is the Assets Under Management (AUM) or the "Fund Size." A common question is: "Should I buy a fund with ₹50,000 Crore AUM or a fund with ₹500 Crore AUM?" This chapter explores the nuances of fund size and its impact on performance, stability, and liquidity.

1. Significance of Fund Size (AUM)

AUM represents the total market value of assets held by the scheme.

Advantages of Large Size:

  1. Economies of Scale: Larger funds can negotiate lower trading costs and have lower expense ratios (SEBI mandates lower fees for larger AUM slabs).
  2. Stability: A large fund (e.g., ₹20,000 Cr) is not easily destabilized if a single large investor redeems ₹100 Cr.
  3. Team Quality: Large funds can afford bigger research teams and better technology.

Disadvantages of Large Size:

  1. Loss of Agility: A manager of a ₹50,000 Cr fund cannot buy small-cap stocks easily. Buying 1% of a small company might not move the needle for the fund.
  2. Market Impact Cost: When a giant fund buys/sells, it can move the market price against itself.
  3. "Closet Indexing": To manage size, managers might just hug the benchmark (buy all Nifty stocks) rather than finding unique ideas.

2. Does Size Matter? (Category Wise)

The impact of size depends heavily on the category of the fund.

A. Large Cap Funds (Size is Good)

  • Verdict: Bigger is generally better.
  • Reason: They invest in top 100 giants (Reliance, HDFC). Liquidity is endless. A ₹50,000 Cr fund can easily trade in these stocks without impact.

B. Small Cap Funds (Size is Bad)

  • Verdict: Smaller is often better (up to a limit).
  • Reason: The investable universe is small. A ₹20,000 Cr Small Cap fund will struggle to find enough good small companies to invest in. It will be forced to hold too much cash or buy inferior stocks.

C. Liquid/Debt Funds (Size is Vital)

  • Verdict: Bigger is definitely better.
  • Reason: Corporate treasuries withdraw massive amounts at once. A small liquid fund might face a crisis if a big investor leaves. A huge liquid fund offers safety and stability.

3. Stability of the Fund House (AMC)

Apart from the scheme size, the AMC's stability matters.

Factors to Check:

  1. Parentage: Is the sponsor a reputed brand (e.g., SBI, HDFC, Tata, Franklin)?
  2. Track Record: How long has the AMC existed?
  3. Process vs Person: Does the AMC follow a process (team-based) or rely on a "Star Fund Manager"? (Star managers can leave; processes stay).

Comparison: Large Size vs Small Size Fund

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Exam Notes: Writing the Answer

Question: "Discuss the impact of Fund Size (AUM) on the performance of a mutual fund." (10 Marks)

Model Answer:

Impact of Fund Size: The Assets Under Management (AUM) is a critical selection criterion, but its impact varies by asset class.

Positive Impact (Economies of Scale):

  • Lower Costs: Larger funds often have lower expense ratios.
  • Survival: Very small funds (< ₹50 Cr) risk being merged or closed down.

Negative Impact (Liquidity Constraints):

  • Agility: Large funds lose the ability to move in and out of stocks quickly.
  • Universe Restriction: In Small and Mid-cap segments, a very large corpus forces the manager to ignore high-growth tiny companies because they cannot deploy meaningful capital there.

Conclusion: For Liquid and Large Cap funds, "Bigger is Better." For Small and Mid-cap funds, "Mid-sized is Optimal."

Summary

  • AUM: Total money managed by the scheme.
  • Debt/Large Cap: Prefer Large AUM for stability and low cost.
  • Small Cap: Prefer Moderate AUM to ensure the manager can still find agility.
  • Expense Ratio: Drops as AUM increases.

Quiz Time! 🎯

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