Of Bollywood, Mutual Funds, and INR 100 Bn AUM

Some of my friends are Bollywood aficionados. They are informed of not only which movies are being screened, but also their box office numbers. As a result, even I have become familiarised with terms such as “the 100 crore club”. For the uninitiated, apparently box office collections of at least INR 100 crores (INR 1 billion) is a parameter for a movie to be considered a success.

Oddly, a somewhat similar scenario is brewing in mutual funds. Thanks to a combination of steady inflows and rising markets, several equity-oriented funds have an asset size exceeding the INR 10,000 crores (INR 100 billion) mark.

However unlike box office numbers, growing assets of mutual funds are giving some investors and distributors sleepless nights.

Is the evaluation parameter apt?

An evaluation parameter must be based on sound logic for it to be relevant.

Let’s consider the 100 crores mark for movies. Say movie “ABC” costs INR 30 crores to make, and its box office collection is INR 70 crores. Compare this with movie “XYZ”, which costs INR 90 crores to make, and clocks proceeds of INR 110 crores.

Now if grossing INR 100 crores is the benchmark of success, then “XYZ” has succeeded, while “ABC” is a failure. However, if cost is considered, it is apparent that “ABC” is more profitable (hence, more successful) versus “XYZ”.

Clearly, selecting an apt benchmark is vital. This principle holds good in the case of mutual funds too.

Does size matter?

Asset size can matter because a mutual fund operates within the restraints of liquidity, market cap, and availability (listed stocks). That said, jumping to a conclusion such as “large asset size=bad, and small asset size=good” would be naive.

Let’s consider small and mid-cap funds. Here, a large asset size can pose challenges in the form of market-impact cost, the opportunity cost of having to spread trades out over longer periods, and liquidity management.

Conversely, a large asset size offers economies of scale. In India, regulations ensure that the expenses charged to a fund reduce, as size grows. In categories such as liquid funds wherein margins are wafer thin, a competitive cost structure aids the investor’s cause in no small measure.

Furthermore, in certain segments of debt markets (such as government securities), the minimum lot size is substantial. As a result, a small-sized fund may not be able to invest in it, thereby depriving investors of a wholesome investment experience.

Simply put, no blanket rule can be applied. The relevance of a mutual fund’s asset size depends on the individual specifics of each case.

Is INR 100 billion a sacrosanct number?

It’s hard to figure out why there is so much focus on the asset size of INR 10,000 crores for equity funds. To begin with, that number isn’t backed by any reasoning. Furthermore, as we learned from the case of the “100 crore club”, a number in isolation means little.

Let’s take the case of a large-cap equity fund with assets of INR 17,000 crores (INR 170 billion). In absolute terms, one might be inclined to believe that the fund’s size is substantial.

However, the size amounts to roughly 0.36% of the S&P BSE 200’s (an apt benchmark index) free-float market cap. In other words, the fund isn't really large.

Conversely, a small-cap fund with a size of INR 5,000 crores (substantially lower than the "hallowed" INR 10,000 crores) could struggle to freely invest without hampering performance.

What investors must do

Instead of focusing on the asset size in isolation, investors would do well focus on the consequences of a growing size.

To begin with, not every portfolio manager is skilled enough to manage a large-sized fund; neither is every investment style adaptable to a large fund.

Look for signs of stress—the manager’s investment style changes sharply, the portfolio acquires a tail which doesn’t add value, the long-term showing consistently falters.

A growing asset size could result in the fund’s character undergoing a fundamental change. For instance, a fund that made its mark as a small/mid-cap fund could end up becoming a large-cap fund.

In such a scenario, investors must evaluate if the fund yet merits a place in their portfolios. If the intention was to invest in the small/mid-cap segment, then corrective steps are in order.

Finally, in cases wherein despite a growth in asset size, there is no discernible change either in the portfolio manager’s investment style and the fund’s character, investors should ignore all the noise and stay invested.