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Why size really matters when it comes to investing

24 October 2018

FE Trustnet considers the advantages and disadvantages of investing in big and small funds and what investors need to keep in mind when picking a fund.

By Maitane Sardon,

Reporter, FE Trustnet

Is M&G Optimal Income too big with £23.8bn of assets under management? How about Terry Smith’s £16.2bn Fundsmith Equity? When does a big fund become too big? And what are the advantages of smaller strategies?

Although investors may not lose sleep over these questions, these, among other size-related aspects, are issues that have an impact on investors’ returns.

The liquidity of certain strategies will also become increasingly important especially when, for example, the current bull market in both bonds and equities comes to a halt and investors want to exit certain vehicles. 

Given the level of volatility in equity markets during the past few weeks and investors’ concerns over when the bull market will end, FE Trustnet asked experts whether investors would be safer in bigger funds or not.

Having spoken with several industry experts, we found that the impact of fund size on one’s investment is determined by many aspects. It can also vary depending on different markets and at different points of the cycle.

As such, with size playing an important part in picking funds, investors should also bear in mind the characteristics of the vehicle in question and where we are in the cycle.

But, is there a minimum size a fund should be?

As AJ Bell’s head of portfolio construction Ryan Hughes noted, when running a fund, there are a number of administration costs that are incurred that can result in the ongoing charges figure (OCF) being particularly high when the fund is small.

As a result, unless costs are being heavily subsidised, it is unlikely that an open-ended strategy can be viable over the long term at less than around £15m.

According to Hughes (pictured), ideally, the fund should be seeing inflows and actively growing to ensure that these fixed costs fall as a percentage of fund assets. This will help the overall OCF fall and help the fund become “cheaper”.

“When we are looking at funds, we tend not to look unless the size of the fund is above £50m and then we want to see a clear direction of travel for it moving towards £100m,” he explained. “At this point in time we are then comfortable that size shouldn’t be an issue in the running of the fund.”


Once smaller funds have reached the right size, they have many positive aspects as opposed to very large ones, including its ability to be nimbler and to trade in small quantities.

“The clear advantage of smaller vehicles is that they can be nimble and take advantage of volatility in the market,” said Hughes.

“At the same time, smaller funds will be able to invest in smaller companies much easier than larger funds which may be beneficial to returns.”

A recent case when size has mattered was seen in last year’s launch of the now £152m GAM UK Equity Income fund, managed by Adrian Gosden.

When taking the helm of the strategy, Gosden – who had previously co-managed the £6bn Artemis Income fund – made clear that he wanted to be able to access mid- and small-cap companies, a key reason that the fund’s capacity was limited to £2bn.

“Gosden clearly feels that this lower level gives him the flexibility to really invest in his highest conviction holdings across the market cap spectrum,” noted Hughes.

Performance of fund vs sector since launch

  

Source: FE Analytics

Although nimbler and flexible, very small funds also risk getting too small to be run profitably for the company or cost effectively for investors.

Adrian Lowcock, head of personal investing at Willis Owen, agreed with Hughes in the £50m in assets as the minimum size investors should look at to avoid fixed costs eating away at performance.

A key consideration, he also noted, has to be the launch date, as a small fund that was launched recently and is growing in assets is not the same as one that started further in the past and keeps struggling to get bigger.

“There is a surprisingly long list of funds below £10m, some of which might be specific mandates or feeder funds, so they don’t necessarily need to be closed but too many are left languishing when the manager should close them.

“In UK small-caps [sector], for example, funds such as MI Downing UK Micro-Cap growth or F&C UK Smaller Companies, with £23.3m and £37.9m of assets under management respectively, are on the smaller side,” Lowcock noted.


At the upper end of the scale, both Hughes and Lowcock agreed that it is difficult to identify funds that have become too big.

The type of the strategy, the investment process followed by the manager, the trading frequency, the asset class, the point in the cycle we are in and the market the vehicle invests in, are all factors to take into consideration.

“Essentially you are looking for that point where performance begins to suffer due to asset size and the shape of the portfolio has to alter to accommodate the assets,” added Hughes “There are some areas where I become more reticent with very large funds or strategies.”

In AJ Bell portfolio construction head’s view, those funds that focus on the micro-cap space are more asset-sensitive.

One example of fund that may have become too big he said is the £1.3bn Marlborough UK Micro Cap, overseen by FE Alpha Manager Giles Hargreave.

“The fund’s size will only really become evident when we have a marked downturn and some liquidity pressures come to the fore, so it will be interesting to see how Marlborough copes,” Hughes said.

In fixed interest, he pointed out some funds can be very large, which makes manoeuvring them quickly in a challenging market more difficult.

He highlighted Richard Woolnough’s £23bn Optimal Income fund as one of those big funds that may have become too big, a fund Willis Owen’s Lowcock also believes is too big even for the bond sector.

As both fund pickers noted, should fixed interest markets become significantly more volatile, it may be difficult for the positioning of the fund to be altered quickly.

Given the infrequency of trading and the buy & hold mentality behind the strategy, at £17bn size is not an issue for Terry Smith’s Fundsmith Equity, they added.

Performance of fund vs sector & index since launch

 

Source: FE Trustnet

Regarding index funds, Lowcock also said tracker funds are also getting larger.

Whilst individually this is not an issue and indeed size helps reduce costs, he said, it is again important to remember that these tracker funds collectively all invest in the same companies.

“If you get a rush for the exit this money could flow out very quickly, hitting valuations in the market,” concluded Lowcock.

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