When it comes to mutual funds, does size really matter?

The size of a mutual fund pertains to the total amount of money or total asset base which a mutual fund manager must manage and invest. There are two types of mutual funds: closed-end fund and open-end fund. For discussion purposes, we will use open-ended mutual funds.

Open-ended mutual funds are known for its great track record of expanding to significant sizes swiftly as investors venture into these funds. There are two ways to grow the asset size of open-ended mutual funds: Inflow of investors’ money and strong performance of bonds and/or stocks in the fund’s portfolio.

The fund manager has to contend with a considerable amount of cash as more and more investors become attractive to a particular fund. Considering that, managers need to make the money work as soon as possible. Some managers may choose to purchase additional instruments not vital for the fund’s investors.

How can we determine if size becomes a hindrance to a fund’s performance? Look at the point the positive relationship between fund size and management efficiency becomes negative. In other words, this is the point at which the negative effects of a fund size neutralizes the positive effects of a fund’s overall return performance. Although it is difficult to determine precisely, when a fund manager can no longer maintain the fund’s investment technique and generate returns comparable to its previous record, the fund has become too huge.

In mutual funds, a fund’s size is connected to its investment style. Some funds suffer when the fund surpasses its investment style. Majority of small cap fund managers employ the stock-picker mentality. Normally, small cap funds have thinly traded stocks, which has the tendency to focus on a small number of stocks. If the small manager becomes successful, and gains new investors and money, he or she may have difficulty buying additional large blocks of thinly traded stocks without pushing the share price up and making it more costly.

Is smaller better? Certain managers prefer a smaller fund for it enables them to move in and out of stocks quickly. Also, smaller funds can be too small, which are known for exceptional short-term performance especially the new smaller ones. But this can be deceiving as a few prosperous stocks in the portfolio could hugely affect the fund’s performance. And since new funds have no long track record, some investors may opt to acquire a fund regulated by inexperienced manager. Aside from that, funds are less diversified; hence, the stock’s low performance can impact the overall portfolio. And lastly, operating expenses can be higher for these funds due to the lower opportunity to maximize the economies of scale.

Going back to the original question, does size matter in mutual funds? Most definitely no. Mutual funds grow and its growth can affect their performance in one way or another. At the end of the day, what matters most is to have a mutual fund that makes you satisfied.