IT’S the time of the year again and Sam plans to invest his bonus. He came across two funds that have good consistent track record, credible fund management companies and low expenses.
That’s when he moves on to the next criteria – fund size. This is where the similarities end: one has a much bigger fund size than the other.
Sam is at a loss. Would bigger funds project a more reliable image? What could Sam do?
If you, too, face Sam’s predicament, consider firstly the size of the fund relative to its mandate or strategy.
A fund specialising in small cap stocks should be correspondingly small but must be big enough to diversify across at least 20 to 25 stocks.
Imagine a RM500 mil fund trying to establish a 5% weight into a small cap stock. The RM25 mil will be equivalent to a substantial 12.5% stake in a small cap stock with market capitalisation of RM200 mil.
Not only would the fund manager have problems buying that much into the stock, eventually he would have problems getting out of it as well.
Operating costs
At the same time, a fund that has a very small fund size may potentially face higher management expense ratio (MER). These consist of the costs like brokerage, audit, trustees, research, etc. A larger fund would be able to achieve better economies of scale and spread out the costs.
That is why funds which are persistently too small to be viable are more likely to be eventually liquidated or shut down.
Sudden increase/decrease in size
Contrary to the belief that more money is better, a sudden or rapid inflow of money can cause a few problems.
Here’s a scenario: A fund is awarded for a series of good performance and everybody starts investing into it. Behind the scenes, the fund manager may not be able to invest the fresh funds straight away, hence most of it will be sitting in cash.
On the other hand, if the fund made its name specialising in quick and agile decisions in small or mid cap stocks, the massive inflow of funds could neutralise its advantage. Performance may eventually suffer.
Sudden decreases in fund size should also be a red flag. There could be reasons happening behind the scenes that you are unaware of that are causing investors to yank money away from the fund.
Conclusions
In our opinion, a fund size of below RM30 mil for a local equity fund would be considered small. An ideal size for a local equity fund to have adequate diversification, liquidity and cost efficiency could be anywhere between RM20 mil and RM300 mil.
Smaller sized funds are also known to be more agile than their larger peers. Before you invest, always conduct your homework. There can be more ways than one to judge a fund.
There could also be exceptions to the ‘rule’. For example, a smaller fund may be able to justify a higher MER by producing higher than average returns. Or a fund manager could be adept at managing significantly more money than the investing style suggest. – Aug 8, 2021
Danny Wong Teck Meng, CFP is the CEO of Areca Capital Sdn Bhd and a certified member of the Financial Planning Association of Malaysia (FPAM).
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
