Size matters when it comes to fund selection. Fund buyers are acutely aware of the need to find the ‘Goldilocks’ fund; one that’s neither too small nor too big. Being too small risks inefficiencies through excessive costs. Too large and there is a danger of liquidity limitations impacting performance. So this begs the question, how big is too big?
First and foremost, why does size matter? If a fund is small, say below £50m, then it could suffer if the costs of running the fund become excessive. If a fund is excessively large, on the other hand, then limitations of market liquidity could erode the manager’s ability to transact in the market and therefore limit their universe and as such limit outperformance.
What should be considered excessively large?
Well, every fund is unique, but there are a few useful reference points. For UK small caps, £1bn is often cited as a good guide to capacity. The more the manager fishes in true small caps rather than mid-caps, the lower that number might become.
At the other end of the extreme, we have US large caps. There are numerous managers running tens of billions in assets in that space, and that is perfectly reasonable given the size of companies available to them. Bear in mind the average S&P 500 company is around £60bn, and even the 20 smallest companies have an average market cap of around £5bn, not too far below the level needed to enter the FTSE 100. It’s worth highlighting that while we have some large funds in Europe, they pale in comparison to many in the US, including several active funds with over $100bn (£73bn).
Size is only half the story
But fund size alone is only half the story. Instead, it is critical to consider strategy size for anything which is mirroring the fund. If the manager has decided it’s time to buy or exit a position, it’s likely to happen across all mirrored funds and strategies. Take an often-quoted example, Fundsmith. Most comment on the size of the onshore fund, which is around £29bn today. However, the mirrored offshore fund is no minor amount, adding a further £8bn.
Extend this example and include any mirrored segregated mandates for the manager you are interested in and the strategy assets become the important number to focus on.
What to watch out for
Reference points aside, how does an investor actually determine whether a fund is too big? A good start will be to consider what the manager sees as their capacity as early as possible. Plenty of fund managers will run their funds as if they are running several billion even if they are only running £100m so that they don’t have to change process over time and be accused of style drift.
Armed with that capacity number, you can be on guard when the AUM reaches the crucial capacity figure. An obvious flag to be aware of is a drift in how the fund is being managed. This can be as basic as an increase in the number of holdings, which allows the manager to buy smaller amounts in each company, or an increase in the average size of company relative to the index.
Another flag could well be an expansion of the universe, for example to include a small proportion of global companies within a UK fund, although this may not always be due to growing assets. For those with the tools at their disposal, analysing the liquidity of underlying portfolios based on their total assets managed is perhaps a more scientific way to approach the problem.
What to do if the fund is too big
In an ideal world, the smaller and nimbler the strategy the better, caveated with the point around a fund being too small. In most areas of the market, you will find smaller and more nimble versions of successful funds. In the global space, for example, there is a glut of funds that look and feel like the highly successful Fundsmith or Baillie Gifford offerings. They all come with strong track records, often have similar philosophies, and are much smaller.
As always, the answer to the question of how big is too big is that it depends. It depends on the manager’s capacity, the area of the market they are targeting and the size of any mirrored funds. Tracking AUM and being cognisant of style drift is key.
Nick Wood is head of fund research at Quilter Cheviot
