A large fund size can be positive, after all, the larger a fund, the more people have backed the manager or strategy. However, funds can get too big, causing problems for investors. Trustnet asked experts how to spot the difference.
This is becoming more of an issue for investors, as the cash that has sat on the sidelines for several years is finally deployed post-pandemic.
According to data from the Investment Association (IA), by the end of 2020 total assets under management reached £9.4trn in the UK, with more than 36 funds running more than £1bn in the IA Global sector alone, a 16% rise on the previous year.
Ultimately there is no ‘golden number’ investors should look for, but there are some warning signs that a fund is becoming too cumbersome to be efficient.
Rob Morgan, chief analyst at Charles Stanley Direct, said if a fund manager isn’t able to fully implement their process or “fully express their views” because of size. This can include, but is not limited to, if the number of companies that the fund can invest in is shrinking, or a natural tendency away from risk.
Third, is liquidity and how easily a fund can sell out of stocks, which is arguably the main issues when it comes to fund size, Morgan said.
“If the manager cannot buy and sell readily in sufficient quantity then it affects their ability to construct the fund in the way they intend. In extreme circumstances it can lead to serious problems.”
The bigger the fund, the larger proportion of shares it needs to own in a company for it to be relevant to the fund’s performance. This could make it harder to sell, as large trades will bring down the share price and, in turn, bring down the fund’s performance.
As well as a liquidity problem this can also hamper performance as the more a fund owns of its investible universe, the closer it is likely to be to a market tracker.
Markuz Jaffe, an investment companies analyst at Peel Hunt, said: “You can’t beat the market if you are the market.”
The analyst added if any of these red flags were raised “it would question whether the fund has the ability to outperform/perform well going forward.”
Whether or not a fund is getting too big has to do with which part of the market it operates in. The US, global conglomerates or even developed market sovereign bonds are all very liquid and scalable assets. Funds here could be in the tens of billions and still be at a healthy size, Morgan said.
An example of this is Fundsmith Equity, the biggest equity fund on the market at almost £27bn. Jason Hollands, managing director of Bestinvest, said some advisers have expressed concerns about how big the fund has gotten in recent years, but he dismissed this, noting that the concentrated fund of 29 holdings is made up of large multi-national companies.
However, if a fund is operating in less liquid parts of the market, such as small-caps or high-yield bonds, a larger fund size “can cause a headache and could be a major disadvantage to the manager,” Morgan said.
This is the case for Liontrust Special Situations and BlackRock European Dynamic, both highlighted as fund’s in danger of becoming too large.
Liontrust Special Situations is currently £6.2bn and the seventh biggest IA UK All Companies fund. According to Hollands, who said “we feel it has gotten too big.”
It has a multi-cap approach but its FE fundinfo Alpha Managers Anthony Cross and Julian Fosh have typically invested a healthy amount in small and mid-caps.
The fund has just 39.3% in FTSE 100 companies, with the remainder split among stocks on the FTSE 250, FTSE AIM and FTSE Small Cap (ex IT) indices.
Hollands said: “At its current size, we feel further growth is likely to make it more challenging to continue to invest such a large portion of the portfolio at the smaller end of the market cap spectrum. In tougher market conditions, especially if a fund experiences large redemptions, it is usually the larger, more liquid positions that will be prioritised for being sold down.”
Bestinvest recently removed the fund from its buy-list because of concerns about its size.
Morgan echoed these concerns, adding that while the management and Economic Advantage process are strong “we have to accept that it can’t reach down into small-caps in quite the same way as it used to now it is a £6bn fund”.
He said that BlackRock European Dynamic “is a similar situation”, at £6.2bn, noting that he was keeping an eye out for those flags in both funds, although had not changed his recommendation on either as yet.
The Liontrust Economic Advantage team said: “We understand that analysts have flagged concerns about the size of the Liontrust Special Situations fund. We’d note that the fund continues to perform strongly at its current size.
“We strongly believe that the Economic Advantage characteristics we look for apply right across the market, so while smaller companies are important for long term performance it’s worth stressing that over 70% of the fund is invested in the FTSE 350.”
BlackRock declined to comment.