Big can be better in a well-managed fund

There is a widespread assumption that super-size funds are necessarily bad. With a few exceptions, such as funds run by Anthony Bolton and Neil Woodford, they are regarded as suffering from the investment equivalent of obesity. From this perspective such funds are like the fat boy at school who was too large to play football properly.

But according to Simon Hildrey’s assessment in this week’s cover story (see page 20) big can be beautiful. A lot depends on the type of fund and the investment process it uses.

Small funds have an advantage in certain markets. In a relatively illiquid market – such as British smaller companies or emerging economies – large funds no doubt can have problems buying and selling shares. Some markets are also too small to accommodate large funds easily.

However, in other types of market large funds can have an edge. In large, liquid markets they can be relatively unconstrained in their actions. The American or British blue-chip markets, for instance, can easily include many giant portfolios.

In such markets large funds also have one important advantage over small ones. Their size means that they enjoy substantial economies of scale over smaller portfolios, because the costs of fund management are spread over a much larger base of assets.

The investment process is another key factor in determining, to use a hackneyed phrase, whether size matters. A fund that depended on the stockpicking inspiration of an individual manager would find it difficult to cope if it became too large. But a fund with a well-defined and systematic investment process should be able to manage larger pools of assets.

Perhaps the most difficult question in this respect is a fund that grows from small to large. In such cases there is clearly the possibility of performance suffering from having to deal with larger amounts of assets.

In these circumstances the first thing to ask is probably why the fund has grown in the first place. It is possible for small funds to do well, certainly over the short term, thanks to luck. Such funds can then take in more assets as investors are attracted by their performance figures. In these cases it is unlikely that strong performance will be sustained.

Conversely, if the strong performance of a fund is the result of a good fund manager then it is more likely to persist. The question then is whether the manager can adapt his style and systems to the new environment.

Despite the fashionable disdain for super-sizing there is a case for it in relation to funds. As long as the circumstances are right, it can work to an investor’s advantage.