Does AUM Size Matter?

Does AUM Size Matter?

There is a general misconception that the AUM size of a mutual fund should first be taken into consideration before making an investment. To what extent is this true? The article, based on a study of different scenarios, concludes whether AUM is a parameter of the success of any fund

Consider a case study of two regular investors in mutual fund schemes. While analysing any particular fund, one of them places quite a lot of emphasis on the size of the fund while the other is agnostic to the factor of assets under management (AUM). So whose approach is right? It’s an important question to dwell upon considering that most investors often find themselves in a conflicting state of opinion when it comes to the role played by the AUM size in mutual fund returns. Do returns really depend on the AUM size?

Defining AUM

The total market value of the net assets that the mutual fund scheme has is referred to as AUM or fund size. The size of AUM is quite an important parameter and does help gain insights about the asset management company (AMC) or fund house. This parameter aids in understanding the business performance of one fund house with respect to its peers. For example, in December 2019, HDFC Mutual Fund was ranked first in terms of AUM and SBI Mutual Fund was ranked third. However, presently SBI Mutual Fund ranks first and HDFC Mutual Fund ranks second. Therefore, this suggests that either the fund house is offering better products or has been making great efforts to market them.

Analysing the AUM also help investors to either get insights into the returns earned by the fund or the inflows that the fund receives or both. And there are three ways in which the fund can utilise the AUM. It can either distribute dividends to investors who have opted for dividend options or can reinvest them to increase returns or they can simply hold as per the investment mandate. These decisions often depend on the strategy of the fund house or the nature of the underlying security. The question now is whether AUM size should be an important criterion in the fund selection process.

There are various categories available in mutual funds but we chose the below mentioned categories only because the impact of AUM is likely to be higher on them:

✓ Large-cap funds
✓ Mid-cap and small-cap funds
✓Debt funds

Large-Cap Funds

There is a general misconception among investors that bigger the fund size the better it is. There is also the notion that the smaller the fund, better are the growth prospects. There is no proof though that the fund’s AUM is determinant of the fund’s future performance. For instance, the AUM of Franklin India Bluechip Fund is `5,504 crore but it generated returns of 31.46 per cent in the last one year. On the other hand, ICICI Prudential Bluechip Fund with AUM of `25,514 crore – which is the highest in its category – generated returns of 25.81 per cent in the past one year. However, even this doesn’t advocate that the lower AUM generates better returns. Taurus Large-Cap Fund with AUM of a mere `28 crore – lowest in the category – has generated returns of 15.45 per cent in the last one year.

Mid-Cap and Small-Cap Funds

If you are considering investing in small-cap funds, then surely a larger fund size does affect them. Usually, small-cap companies hold growth potential and have more room to grow unlike large-caps. Though these are likely to provide high returns, liquidity is something they lack in. This means that when the fund house wishes to sell the shares, it might take more time to execute those sell orders than it takes for the

In Debt MF, Liquid funds have the highest Assets of Rs3.81 lakh crore and in equity MF large-cap funds has the highest assets of Rs1.74 lakh crore as of January 2021.

MF page - 11large-caps. Furthermore, it also comes with higher impact cost when compared with large-caps.Hence, for small-cap funds it becomes quite challenging for a fund manager to manage higher AUM. Therefore, you may see a lot of small-cap funds restrict inflows temporarily. They may either stop accepting systematic investment plans (SIP) or lump sum. This situation happens when the AUM of the fund rises beyond a certain level. On the other hand, in case of mid-cap funds, the underlying companies tend to have slightly more liquidity and a ballooning fund size often gets accommodated by the fund managers.

Debt Funds

Typically, debt mutual funds highly depend on their AUM to manage their returns. A debt mutual fund having large AUM is in a better position to distribute fixed fund expenses across its investors. Therefore, this would help debt funds to have lower expense ratio per unit holder which in turn gets reflected in the fund’s returns. Also, the back-to-back credit events have timely shown us the importance of high AUM in debt funds. Therefore, while investing in debt funds, do consider AUM as one of your screeners.

In fact, when you are considering investing in liquid funds, consider investing in a fund with AUM greater than Rs20,000 crore. The rationale behind this is that most of the corporates park their excess cash in liquid funds and their redemptions are of higher amounts. Hence, a liquid fund with low AUM might face liquidity issues. In case of other debt funds, AUM above Rs500 crore is desirable.

The Study

In order to understand whether the AUM of the fund defines it returns, we carried out a study wherein we took equity and debt funds’ AUM along with their one-year, three-year and five-year trailing returns. Given this sample, we found out the correlation between the AUM of equity and debt as an asset class with that of their respective returns. Further, based on their AUM we divided equity and debt funds into four quartiles namely, Q1, Q2, Q3 and Q4. With this we calculated the average one-year returns in each quartile.

The above graph shows the correlation between one-year, three-year and five-year trailing returns with that of AUM.

So, if we look at it asset class-wise then there is hardly any correlation between the fund’s AUM and its ability to perform well

The above graph shows the average one-year trailing returns of equity mutual funds with AUMs falling in the respective quartiles. And here we see that there is no clear pattern. In fact, the average one-year trailing returns of the equity funds falling in Q1, Q3 and Q4 are nearly the same. However, the funds falling in Q2 gave the highest returns.

The above graph shows the average one-year trailing returns of ebt mutual funds with AUMs falling in the respective quartiles. And as we move from Q4 to Q1, the returns seem to be in a rising trend. Though we cannot simply attribute it to the higher AUM, yet, this is likely because of lower expense ratios. Therefore, purely in terms of AUM there is no pattern that we can witness here. Hence, while selecting mutual funds, it is not at all prudent to invest in a particular fund just because it has a higher or lower AUM. In fact, AUM should be approached from a liquidity perspective.

Conclusion

Though AUM is one of the most important parameters in mutual fund selection, a lot of investors have misconception regarding AUM. Some feel higher AUM means better performance while others feel that lower AUM means more scope for better performance. Therefore, to understand it better we carried out a study. Our research shows that there is no pattern, at least in equity mutual fund, which indicates that higher or lower AUM implies better performance. And in case of debt funds, even though there seems to be a trend, it can simply be due to lower expense ratio with higher AUM.

Therefore, we can conclude that in our case study neither investor’s approach is correct. We believe that one should not base his investment decision just on AUM. There is a need to consider other parameters too. AUM should be viewed from a liquidity perspective. For instance, small-cap funds with higher AUM might take some time to sell off their underlying security, whereas in the case of large-cap funds it is easy. And in case of debt funds, higher AUM means better liquidity which can help investors to dodge credit events.

 

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