Q: I see that Kotak Standard Multicap has an AUM of about Rs 29,000 crore.What is the maximum AUM size one can consider for each category – large cap, mid cap, small cap and multi cap? Many of the funds have not been able to sustain returns as the fund size keeps growing.
Is it because of fund size, partly or entirely? Better-performing equity funds seem to be from lesser-known AMCs like Mirae, Canara Robeco, Parag Parikh and so on, and not from the bigger AMCs like HDFC, Nippon life, ICICI Pru or SBI.
A: Money chases performance. But it is not always that fund performance goes down with inflows. Let us first look at the advantage of size when it comes to cost.
What is AUM?
First, let’s understand the concept of AUM – assets under management. What is this AUM, really? It is nothing but the total sum of all the ‘assets’ managed by the fund manager of a particular scheme. And by assets we mean all the moneys in different forms – stock holdings, bond holdings, cash, holdings in other mutual funds as may be etc. The AUM of a fund can increase in two ways – one, as investors pour money into a fund in the form of investments, the AUM naturally increases. But the AUM can also increase when the value of the investments made by the fund manager grows. Conversely, when investors withdraw money and/or when the market goes down, the AUM of a fund goes down. As AUM increases (or decreases), the question is whether it impacts the ability of a fund manager to manage the fund.
AUM size and cost advantage
SEBI provides a slab of the maximum expense ratio mutual fund can charge based on the size of its assets. This slab moves down from 2.25% for equity and equity-oriented funds below Rs 500 crore, to 1.05% for assets above Rs 50,000 crore (we are talking of equity and equity-oriented schemes alone here).
For example, the expense ratio of a Principal Focused Multicap’s direct plan, with under Rs 400 crore of AUM, was 1.8% as of July 2020. Whereas, the expense ratio of Axis Focused 25 (over Rs 11,000 crore) was just 0.67%.
Specifically, when AUM crosses Rs 10,000 crore, the total expense ratio (TER) should be lowered by 0.05% for every Rs 5,000 increase in AUM. Look at the example below:
There is clearly a 5 basis-point difference in the above funds with increased AUM, although they are not way away from each other. Thus, the slab ensures that funds reduce expense ratio with AUM growth.
Sector funds and international funds, typically with low assets and more active management, have a far higher expense ratio.
Essentially, there is advantage in size. Size also helps provide liquidity – to meet any redemptions without the need to sell quality stocks. So size is a not bad thing from a cost perspective.
Fund AUM size and performance
Next, it is partly only a perception that the larger fund houses have large equity AUM. It’s not the case in reality.
First, only 26 of the around 430 equity-oriented schemes have AUM of over Rs 10,000 crore.
Take SBI, which is the largest AMC by assets. In the equity-oriented space (other than ETFs), the fund house has just 1 hybrid scheme (SBI Equity Hybrid) and 1 equity scheme (SBI Bluechip) with over Rs 20,000 crore of AUM. All the other schemes have less than Rs 10,000 crore AUM. And remember, hybrid schemes deploy in debt as well. Hence, size is not an issue in this category.
Here’s another example – just 3 out of 10 pure equity schemes (i.e., not including hybrid) in HDFC have an AUM of over Rs 10,000 crore. Of these, just one equity scheme is over Rs 20,000 crore. Similarly, not a single scheme in Nippon AMC is over Rs 20,000 crore crore and just one scheme is even over Rs 10,000 crore.
As far as the ‘large’ AMCs and fund sizes go, the following is worth noting:
- Many of the yesteryear top performers in the ‘large’ AMCs are no longer among the top performers. Money moved away from them. One can say it is a self-correcting mechanism.
- Such AMCs may continue to look large on a whole due to liquid and debt money from institutional space and because of their vintage (as MF is a slow growing business and takes time to scale). But the equity schemes in these large AMCs are not necessarily large.
- Money moving away does not necessarily improve fund performance. For example, Aditya Birla Sun Life Frontline Equity’s AUM fell from Rs 20,200 crore 2 years ago to Rs 17,400 crore in July 2020.
- The reverse is also true that money has flowed into funds that show performance and yet these funds have managed to do well. The table above will show you that many of the top performing funds have AUM of over Rs 10,000 crore.
Let’s take the one of the fund houses mentioned in this query. Mirae Asset Emerging Bluechip has the largest AUM in the large and midcap category (despite restricting flows) and still does very well. Axis Bluechip has about Rs 16,000 crore of AUM and is among the top in the large cap equity fund category.
- When funds perform well, money chases them.
- When fund performance slips, money moves to the next performer.
- Whether this is ideal or not is a separate debate. But fact remains that there are funds that manage performance with larger AUMs too. And funds that have lost AUM have not necessarily become better.
Where size is a deterrent
So, it boils down to which segments are more vulnerable to scale. Just to give a perspective, a fund with Rs 20,000 crore of assets would account for under 0.3% of the free-float market cap of the listed space. In that sense, it may not be correct to generalise that such a fund size is too large for it to deploy money efficiently. This is the case with a fund like Kotak Standard Multicap with predominant exposure to large-cap stocks.
But if a scheme happens to be a mid-cap fund with Rs 20,000 crore of asset size, it will account for 2.1%of the mid-cap free float. If the same fund happens to be a small-cap fund that would be 5% of the small-cap free float.
Essentially as you go down to investing in smaller sized stocks, a large fund asset size can have a significant impact in that market cap segment – both while selling and buying stocks.
The impact is as follows:
- They may not be able to buy or sell at desired price. They must gradually deploy and sell in a phased manner. The result? They may not get a stock at the price they desired even though they identified it early.
- They may not realise all that you see as ‘paper profits’ since their selling price may be at various levels – often lower than where they started to sell.
- Fund managers may find it difficult to deploy large sums at once and must sometimes resort to larger stocks (even in mid and small-cap categories) to ensure there is liquidity in the portfolio. This is turn, can also impact performance.
- Besides, as large money flows in, getting ideas and spotting opportunities in the mid and small-cap space can be hard given the limited number of quality companies in the space, in the Indian context.
To summarise the points on fund size and performance:
- Performance matters more than asset size except in some segments such as mid and small cap and categories like arbitrage. For example, in categories like midcap or small cap we have seen funds struggling to deploy higher AUM.
- When you see a mid or small cap fund slowly deploying more in large cap than they were earlier, it is a warning sign that they are unable to plough the money easily in smaller companies for fear of higher impact cost. These are the signs we watch for.
On optimal AUM size
There is no such thing as optimal AUM. In general (please note this is NOT a rule and we don’t stick to it) we have noticed funds struggle a bit when they cross Rs 20,000 crore in midcap space and Rs 7,000-10,000 crore in the small-cap space in the past 3-5 years.
Please remember this number was Rs 8,000-10,000 crore for midcaps and Rs 4,000-5,000 crore for small caps a decade ago because the market cap of stocks was lower than they are now. So, it is to do with the size of the market. This number will change even in 5 years’ time. Hence, it is hard to quote an ‘optimum’.
For a multi-cap like say Kotak Standard Multicap that is mentioned in this query, Rs 29,000 crore is still under 0.3% of the total market cap of just the top 100 companies. So, the issue of challenges in deployment and management does not arise, when a fund’s mandate provides adequate inclusion of large-cap companies. It will boil down to performance and opportunities.
At PrimeInvestor, we already consider all these factors and go by slippages in performance vis-a-vis portfolio AUM and portfolio liquidity than looking at a fixed AUM. This is one of the criteria we use in our choice Prime Funds.