People often assume that the bigger something is the safer and better it is. In the managed funds industry bigger is not always better. So much so that some of Australia’s best known fund managers are choosing to close their doors to new money in order to maintain their returns.
Investors might gain some comfort if they invest in a large fund rather than a smaller fund.
However, few would realise the potential drawbacks of large funds. There is a growing body of academic research that suggests that next to stock picking, a fund’s size has the biggest impact on its performance. If you look at the fund managers with the best returns they are generally those that are ‘nimble’. By nimble I mean they possess the ability to enter and exit positions efficiently. Consequently, one of the top criteria for recommending a fund is its ability to capitalise on opportunities rather than naively looking at just its size.
If a fund becomes too large, the manager may be forced into taking positions when they would prefer to be on the sidelines. For instance, small-cap managers that get too big are forced to invest in larger companies. On the other hand, large cap managers that get too big end up diluting their best ideas by having to invest in smaller companies.
There are no hard and fast rules for investors who want to know if a manager is too big for its market. Most professional investors are aware that if a fund accounts for more than 1 per cent of the capitalisation of the market they are investing in, they are at risk of sabotaging their own returns. Additionally, a manager’s investment style and the asset class they are investing in will dictate where capacity impacts returns.
A point to note is that boutique firms are less prone to getting too big because the managers themselves are in charge of the business and they tend to be more attuned to their performance and in turn their reputation.
Keep this in mind when assessing the merits of investing in a managed fund.
That’s it for this month
Bye for now
Source: The Australian Financial Review 21 May 2014 Matthew Smith