Does fund size affect the performance of equity mutual funds? A recent working paper at the Yale School of Management involves an empirical study in the Indian context. It’s notable as the principle of ‘economies of scale’ is not an exception to the realm of finance and investment. The study aims to ascertain the degree or extent of relationship between fund size and actual performance when it comes to returns on asset management. The research reveals rather surprising results for Indian mutual funds.
The mutual funds industry in India had assets worth over Rs 7 lakh crore under management as of July 2009 with the bulk of it in debt funds. There are now 36 asset management companies (AMCs) in the MF ‘space’. Meanwhile the regulator, Sebi, has mandated doing away with the levy of ‘entry loads’ for MF investors. It is distributors who have traditionally pocketed the ‘load’ as commission. So, AMCs would need to figure out innovative marketing and perhaps also hand out “out of pocket” commissions for product distributors. The correlation between fund size and returns is seen as relevant because when a corpus is sufficiently large, the fund managers involved would likely have the necessary liquidity and flexibility for timing investment decisions and stock selection. Additionally, size has the added advantage of reducing transaction costs by resorting to bulk ‘buys’. The paper uses data of a three-year period: April, 2006 to April, 2009. Also, while the total number of open-ended equity/growth funds totalled 244, the sample size chosen was 22, with a mix of micro, small, medium and large-size funds. Next, the net asset values of the select equity funds were worked out for the first trading day of each quarter of the 3-year period for computing the return (CAGR), risk and return per unit of risk and risk adjusted return (Sharpe Ratio) of the funds.
The actual fund sizes varied from Rs 9.57 crore to Rs 2,472.36 crore. The funds labelled ‘micro’ had less than Rs 100 crore under management; those characterised ‘small’ had a corpus of less than Rs 500 crore; medium pertains to less than Rs 1,500 crore; and large-size funds were those with up to Rs 2,500 crore under management.
In the paper, the concept of momentum (mass*velocity), a popular concept in physics and mechanics, has been incorporated to engineer a new concept termed ‘fund momentum’ construed as the product of fund size and CAGR.
The results of the study suggest that all the performance parameters such as return, risk, return per risk, return per fund size and Sharpe Ratio were found to be negative. But then, overall the stock market returns for the period under study was negative. From econometrics testing of the hypothesis, it is clear that the correlation coefficient of fund size and performance variables are ‘not significant.’ So there’s no ‘conclusive evidence’ in the paper that fund size affects performance of equity/growth funds, whether they are micro-, small-, medium- and large-sized funds. Further, the variances between fund size and performance variables show that barring risk, the other three parameters–return, return/risk and Sharpe Ratio–move together in the same direction and the values are seen as ‘random’ and no conclusive evidence may be drawn about fund size and performance of equity/growth funds across the size range.
Besides, the small-sized funds seem to have performed better than micro-, medium- and large-sized funds in terms of return per risk and risk adjusted return. The Weighted Average Momentum (WAM) of the small-sized funds was found to be the second best after that for micro-sized funds which, anyway, added up to a mere 2.02% of the total fund size of equity/growth funds. Hence the paper considers the performance of small-sized funds as the best in terms of WAM. As for the medium- and large-sized equity/growth funds, they were quite unable to outperform the overall stock market in terms of returns. So when it comes to mutual funds in India, ‘small’ appears to be beautiful.
The mutual funds industry in India had assets worth over Rs 7 lakh crore under management as of July 2009 with the bulk of it in debt funds. There are now 36 asset management companies (AMCs) in the MF ‘space’. Meanwhile the regulator, Sebi, has mandated doing away with the levy of ‘entry loads’ for MF investors. It is distributors who have traditionally pocketed the ‘load’ as commission. So, AMCs would need to figure out innovative marketing and perhaps also hand out “out of pocket” commissions for product distributors. The correlation between fund size and returns is seen as relevant because when a corpus is sufficiently large, the fund managers involved would likely have the necessary liquidity and flexibility for timing investment decisions and stock selection. Additionally, size has the added advantage of reducing transaction costs by resorting to bulk ‘buys’. The paper uses data of a three-year period: April, 2006 to April, 2009. Also, while the total number of open-ended equity/growth funds totalled 244, the sample size chosen was 22, with a mix of micro, small, medium and large-size funds. Next, the net asset values of the select equity funds were worked out for the first trading day of each quarter of the 3-year period for computing the return (CAGR), risk and return per unit of risk and risk adjusted return (Sharpe Ratio) of the funds.
The actual fund sizes varied from Rs 9.57 crore to Rs 2,472.36 crore. The funds labelled ‘micro’ had less than Rs 100 crore under management; those characterised ‘small’ had a corpus of less than Rs 500 crore; medium pertains to less than Rs 1,500 crore; and large-size funds were those with up to Rs 2,500 crore under management.
In the paper, the concept of momentum (mass*velocity), a popular concept in physics and mechanics, has been incorporated to engineer a new concept termed ‘fund momentum’ construed as the product of fund size and CAGR.
The results of the study suggest that all the performance parameters such as return, risk, return per risk, return per fund size and Sharpe Ratio were found to be negative. But then, overall the stock market returns for the period under study was negative. From econometrics testing of the hypothesis, it is clear that the correlation coefficient of fund size and performance variables are ‘not significant.’ So there’s no ‘conclusive evidence’ in the paper that fund size affects performance of equity/growth funds, whether they are micro-, small-, medium- and large-sized funds. Further, the variances between fund size and performance variables show that barring risk, the other three parameters–return, return/risk and Sharpe Ratio–move together in the same direction and the values are seen as ‘random’ and no conclusive evidence may be drawn about fund size and performance of equity/growth funds across the size range.
Besides, the small-sized funds seem to have performed better than micro-, medium- and large-sized funds in terms of return per risk and risk adjusted return. The Weighted Average Momentum (WAM) of the small-sized funds was found to be the second best after that for micro-sized funds which, anyway, added up to a mere 2.02% of the total fund size of equity/growth funds. Hence the paper considers the performance of small-sized funds as the best in terms of WAM. As for the medium- and large-sized equity/growth funds, they were quite unable to outperform the overall stock market in terms of returns. So when it comes to mutual funds in India, ‘small’ appears to be beautiful.
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