Funds: does size matter?
In fund management, big can be beautiful. It means a fund manager is popular and has usually generated good returns over a long time. Big can also mean economies of scale, making funds cheaper for investors.
However, big can also turn ugly. the history of fund management is littered with funds that became too big and saw performance slide. How can investors judge whether they have a goldilocks fund – not too big, not too small, but just right?
The issue has come to the fore recently because a number of big, popular emerging market funds have closed to new investors – either by raising the initial investment beyond the reach of private investors or by hiking initial charges to unattractive levels. they have done this because they are worried that the size of the funds may hamper strong performance in future.
Equally, a number of fund managers have raised concerns about the size of some corporate bond funds. the m&g franchise, for example, has been hugely successful and Richard Woolnough's Optimal Income and Corporate Bond funds are £12.2 billion and £6.1 billion in size respectively.
Parts of the corporate bond market have seen relatively few new bonds coming to market, weakening liquidity.
The big problem
Funds operating in niche or illiquid areas such as smaller companies, where trading volumes are lower, can move the price if they are too large. a smaller fund can move in and out of the market with no difficulties. no one notices. But with a larger fund, the market can get wind of the fund manager wanting to buy or sell and will demand a higher or lower price for the shares.
Jason Hollands, managing director of business development and communications at Bestinvest, says there can be other, more serious implications as well: "Put simply, a £1 billion fund allocating 3% of the portfolio to a stock position means it needs to deploy £30 million.
That means it simply can't touch minnows as, under the uK takeover Code, once you end up owning more than 30% of a company you are obligated to make a bid for all of it. In reality, most fund managers don't want to hold positions anywhere near that level."
But big is not always bad. Tim Cockerill, head of research at Ashcourt Rowan, says: "there is no evidence that large funds 'must' perform poorly. the evidence I see – and both aberdeen and first State bear this out – is that large funds can perform."
Equally, small is not always good. It's becoming more difficult for managers to run smaller funds. The cost of compliance is increasing and, as this is a fixed cost, it drags on the overall performance. And Architas chief investment officer Caspar Rock points out that small investment boutiques are now having to fork out for more expensive research, now the investment banks have cut back on what they can provide.
So how do investors tell whether a fund is the right size? First, they need to look at the type of asset.
Cockerill says: "In the case of a UK small-cap fund, if greater than £500 million, then I think it is getting too large. For example, the Standard Life UK Smaller Companies fund is £1 billion but has 4% in FTSE100 and 63% in mid cap. It's been a good fund but it isn't small cap."
Justin Oliver, investment director at Collins Stewart Wealth Management, says investors also have to ask themselves why they are holding the fund. For example, he holds Neil Woodford at Invesco Perpetual for exposure to areas such as tobacco or utilities.
The size of the fund matters less in this situation, but he adds: "Investors have to be more careful in the less mainstream assets. It is all about the liquidity in the underlying market. There are certain areas, such as infrastructure, which suit a closed-ended vehicle (investment trusts)."
Cockerill says his ideal fund would be between £250 million and £1 billion in size: "These funds have flexibility that larger funds don't have and can benefit from holding smaller companies that would be swallowed up in large funds."
Investors also have to trust their fund manager. Groups such as JO Hambro Capital Management caps all its funds in consultation with its fund managers, who should be best-placed to know when size is becoming a problem. There is an inherent conflict, however, in that fund management groups make money on a percentage of assets under management, so it is in their interest to have larger funds.
But many are now realising that gathering assets to the detriment of performance hampers their business prospects in the long run.
Investors have to be careful about fund size, particularly in niche and illiquid areas, such as smaller companies, emerging markets, and areas such as infrastructure. In these areas it may be worth considering investment trusts, which do not have the same problems.
Three small funds to switch to
OUT: M&G Corporate Bond
IN: Kames Investment Grade Bond
"M&G wants to slow inflows into this fund and its other corporate bond fund, M&G Strategic Corporate Bond. Both now have more than £5.5 billion in assets under management and M&G doesn't want performance or liquidity to become an issue.
"I like the Kames Investment Grade Bond fund as an alternative. It has a well-resourced and experienced team behind it, like the M&G funds, and is a consistent performer with a similar yield level."
OUT: Fidelity South East Asia
IN: Schroder Asian Alpha Plus
"The Fidelity fund is growth oriented with a bias towards mid- and large-cap stocks. The manager focuses on high-quality stocks and has a one to two-year time horizon for his investments. It was the go-to fund in the sector for many years but performance in recent years has not been as strong.
"My alternative is the Schroder Asian Alpha Plus, which is also growth orientated with a bias to the same sized companies – mid and large."
OUT: Schroder UK mid 250
IN: Franklin Templeton UK mid Cap
"The Schroder fund is around £1.3 billion but got as large as £3 billion at its height in popularity. Performance of this fund did suffer, although shorter-term performance has picked up again.
"For me, the stand out fund in this area is the Franklin Templeton UK Mid Cap fund, which has around half the assets under management of the Schroder fund. It has a flexible strategy – neither growth nor value. And the UK equities team is autonomous from the rest of the organisation, focusing purely on this market with no other distractions."
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.