(This article was first published in The Economic Times.)
When it comes to picking mutual funds, investors often go for schemes with larger assets under management (AUM). Since a larger group of investors has put its faith in a particular fund, it seems reasonable to invest in it.
Does this mean you should ignore the smaller funds? No, say experts. “An investor should see if the smaller fund is delivering steady returns or not.
Also, they should be concerned with the fund being true to its mandate, not focus on its size,” says Nilesh Shetty, Fund Manager, Quantum Long Term Equity. What Shetty says holds true for his small sized fund. Quantum Long Term Equity, which despite offering just a direct plan, sold only by the fund house not distributors, has attracted investor attention because of its superior performance across market cycles.
The fund has delivered substantially higher returns over three and one-year periods—17.45% and 14.66% respectively—compared to the category average and the benchmark index. It is not the only small fund to have beaten its large category peers.
Small funds have fared better
Some small-sized schemes have delivered twice the returns compared to their category average.
Returns as on 21 Dec 2016. Assets under management (AUM) as on 30 Nov 2016. Source: Value Research.
Bigger funds are usually more in the news, are advertised and the high AUMs of the schemes are flaunted by the fund houses. However, for an investor, size should not matter. Investors should see if a fund has delivered superior risk-adjusted returns over different market cycles. If its long-term returns are not impressive, then the fund should be avoided, irrespective of its size.
The fund should also be true to its mandate and have a competent fund management team. If a small fund meets these criteria, it is worthy of investment. “If the fund is from a reputed stable, is managed by a good team and is doing well, we recommend it to our clients even if the AUM is less and they do invest in it,” says Avinash Damani, AMFI-certified fund distributor.
Big advantage of small funds
While a larger fund finds it tougher to react quickly to special market situations in terms of buying or selling stocks, it is not so with smaller funds. For instance, if a big fund with an AUM of Rs 5,000 crore wants to have 2% of its fund invested in a promising company, it would have to buy stocks worth Rs 100 crore.
In comparison, a smaller fund with an AUM of around Rs 500 crore will have to buy stocks worth only Rs 10 crore to have 2% of its portfolio in the company. Buying stocks worth Rs 10 crore, naturally, is easier than buying stocks worth Rs 100 crore. The bigger fund might even have to spread its investment over days, which might result in an opportunity loss.
The same would apply at the time of selling a stock. A smaller fund would be able to get rid of an underperforming stock much quicker than a bigger fund. “A smaller mid-cap fund can definitely perform better than a larger midcap scheme,” says Pankaj Tibrewal, Fund Manager, Kotak Mid Cap.
Consider the example of Principal Emerging Bluechip, which has an AUM of Rs 663 crore, and Franklin India Prima with an AUM of Rs 4,566 crore. A look at the portfolios of these mid-cap funds, both with five-star rating by Value Research, shows that the former has a turnover ratio—an indicator of the frequency at which a fund buys and sells stocks—of 72% and the latter 25.06%. Since a higher ratio means that the portfolio is churned more often, it is clear that Principal Emerging Bluechip is nimbler with its stock movement.
Of course, a lower turnover ratio can also mean that Franklin India Prima consciously avoids churning its portfolio and follows a buy and-hold strategy. However, the ability to frequently churn the portfolio seems to have worked in favour of Principal Emerging Bluechip which has outperformed Franklin India Prima over three- and one year periods.
Just like Principal Emerging Bluechip, several small funds have performed substantially better than their large category peers. This reinforces the point that investors should choose a fund based on its performance across market cycles, investment mandate and management team—not its asset size.