UK Edition
'Big funds are more of a problem than small funds'
Big is not always beautiful when it comes to investment funds. Large funds can find it harder to buy and sell investments, and managers may be forced to invest in areas they would otherwise avoid, all of which can hit returns.
Events this week illustrate the problem. Shares in Provident Financial, the subprime lender, fell by 70pc after it said profits would be lower than previously expected. Giant funds such as Neil Woodford’s £10.3bn Woodford Equity Income and Invesco Perpetual’s £10.9bn High Income and £5.4bn Income fund have large stakes in the company.
If Mr Woodford, for example, had wanted to sell some or all of his holding as a result of the bad news, he would have struggled to shift such a large stake at an acceptable price – while there are always buyers, there might not be enough around to buy a stake as large as Mr Woodford’s. As it is, the star manager said he was confident that the shares would recover.
“Common sense says that as funds get bigger they become harder to manage,” said Robert Burdett, who runs “fund of funds” portfolios for BMO Global Asset Management. He focuses on smaller asset managers.
“There is an unwritten, unsaid truth that there is a conflict of interest when funds get ever larger, with most of the benefits going to the fund management group with higher fees and margins, but the fund becoming harder for the fund manager to run,” he said.
But how easy is it to spot when a fund is getting too large? It’s not just a case of avoiding all funds over a certain size, said Mr Burdett.
Instead it depends on what they invest in, the manager’s style and the size of the companies they buy. Investors should also look at the size of any other funds that the manager runs to a similar investment style, such as any pension funds or investment trusts.
“If a manager typically invests in FTSE 100 stocks it is highly probable they will manage more money than they could manage if they invested in very small companies,” said Ryan Hughes of AJ Bell, the fund shop.
However, Mr Burdett said his rule of thumb was to consider capacity when a mainstream fund reached £1bn and when a fund that invests in small and medium-sized companies hit £500m.
Typically, he said, larger asset management groups are not as good at closing funds when they have reached capacity, while smaller firms are more likely to state at the fund’s launch the amount of money they will manage and then stick to that.
Downing, the asset manager, closed its UK Micro-Cap Growth fund this year when it reached £30m, for example. The fund invests in around 30 very small companies, typically with a market value of less than £150m.
Judith MacKenzie, who runs the fund, said: “Size is critical to maintaining the integrity of the track record.”
Tom Becket of Psigma Asset Management said he had sold his holding in Invesco Perpetual Income, run by Mark Barnett, and First State Asia Pacific partly because of worries about fund size.
Other things to look out for when funds get larger include whether the manager’s investment strategy changes. For example, the number of companies they invest in may start to creep up.
“It might have been 50 holdings and then it’s 65 or 70,” said Mr Hughes. “They tend to add more very small positions.”
This is easy for DIY investors to monitor by checking fund factsheets. They should also look at whether the fund has started to invest in larger companies, he added.
Funds can be forced to do this when their size increases to the point that stakes in smaller firms are incapable of contributing meaningfully to performance without taking an excessively large stake in each stock.
Mr Hughes added: “There is no one killer answer. Typically it is only after the event that you say ‘probably that fund took on too much money’. It is very, very hard to get it at the right time.”
Bond funds are not immune from this problem either, particularly given current concerns about the market’s “liquidity” – the ability of managers to sell their assets if needed.
Mr Becket said that because of these concerns he had sold all his large, mainstream bond funds and switched to smaller managers.
“Funds that are too big need much more scrutiny than funds that are too small,” he said. “Most people won’t invest in a fund because it is small or doesn’t have critical mass, but big is often not beautiful in the case of investment funds.”