8th February 2013
Can a fund get too large for its fund manager to handle asks investment journalist Cherry Reynard
Aberdeen is taking steps to stem the inflows into its mighty Emerging Markets fund. At £3.7bn, operating in illiquid markets, the group has concluded that it needs to take action to shore up fund performance reported here on Trustnet. It is not alone, the recent bull run has seen a number of popular funds nearing capacity limits – JO Hambro Japan, Fidelity UK Smaller Companies and the Trojan Income fund. What does it mean for investors?
If a fund management group believes it has capacity issues, then investors should take note. Fund managers are paid as a percentage of assets under management and restricting inflows hurts their profits. Responsible managers will cap flows in the interests of existing shareholders, to ensure performance does not suffer, but the history of fund management is littered with groups that have been too greedy. Popular managers have been left managing too many assets and have found themselves languishing at the bottom of performance tables as a result.
Fund managers will aim to stem flows through a variety of means: they may cease marketing activities, or discourage advisers from putting the fund on their 'buy' lists. They may hike the charges in the fund to make it less attractive. Alternatively, they may push up initial investment levels from, say, £1,000 to £250,000 to discourage retail investors.
Jason Hollands, managing director – business and communications at Bestinvest, says the trend to 'soft close' successful funds when they reach a certain size was not a feature of the market a decade ago and means fund managers rather than sales team have the upper hand: "A decade ago sales and marketing teams at fund groups would relentlessly promote funds while they were riding high in the performance tables till they ballooned in size and the portfolios looked very different. In our view the increase in soft closures is also a sign that top fund managers now have more influence within their firms as they do not want to blow their track records." He gives examples of other funds currently soft closed: Standard Life UK Smaller Companies and First State’s Indian Subcontinent, Greater China Growth, Latin American and Asia Pacific Sustainability funds.
What is the problem with large funds? Potentially nothing, if the manager is skilled and follows a certain type of strategy. However, it can make it difficult to move in and out of large positions. If other market participants know that a manager is trying to exit a position, they may offer a lower price for the shares. This is particularly true in declining markets. Smaller funds can move in and out of positions without anyone noticing, larger funds can move the share price.
Managers such as Neil Woodford at Invesco Perpetual, have successfully run multi-billion pound portfolios for years. He deals mostly in larger capitalisation stocks with good liquidity. His style is also contrarian, meaning he will generally be buying when other people are selling, which partially solves the problem of the market moving against him. However, it can be very difficult to move in and out of positions in smaller or emerging market companies with less liquidity.
How big is too big? Judging whether a fund is too big to be successful is certainly an art rather than a science. Groups such as JO Hambro Capital Management consult their fund managers, examine the strategy and the market liquidity and set a limit to the fund size at the outset. This is relatively rare, but has helped preserve good performance across the group's funds. Often investors won't know until it is too late. This has been seen with strategies such as the Schroder UK mid-Cap fund, where size has undoubtedly played a part in its relatively weak recent performance against the wider mid-cap sector. It has also hit some of the popular smaller companies funds, such as those from Artemis.
It should be noted that this can hit bond funds as well as equity funds. Kames bond manager Stephen Snowden has been vocal recently about the problems of liquidity within the bond market and how that can hurt investors as trade website FTAdviser.com reports.
This piece from US site Smart Money offers some thoughts on judging whether a fund has become too large. As a result, many advisers welcome the fund managers making that judgement. Darius McDermott, managing director of Chelsea Financial Services, says that he supports Aberdeen's actions because they are looking after their existing investors, but adds: "We are obviously disappointed that new investors won't be able to invest in this fund, particularly as there is a lack of competition for decent alternatives in the sector."
Patrick Connelly, head of communications at AMD Chase De Vere says: "We are fully supportive of Aberdeen’s decision to soft close the fund. They could clearly take in much more money but have made this decision in the best interests of existing investors and at the possible expense of their own revenue stream.
"Fund size is very important and we have concerns about funds which are both too small, from a liquidity perspective, and too large, which means they can become inflexible. However, whether a fund is too large depends upon the type of stocks being invested in and the approach of the manager.".
It is tempting to conclude that investors should always opt for smaller funds, but there is an optimum level. Too small and fixed costs act as a drag on performance. A recent survey by analytics provider PerTrac found that 'large' funds (those over $500m) outperformed those under $100m and exhibited less volatility reported on trade site InvestmentEurope.net.
There is no ready answer to the conundrum of whether a fund has grown too large to perform properly, but it is always worth thinking about alternatives. Investors can sometimes going for the obvious choice, pursuing 'hot' funds while a smaller, more nimble alternative is waiting just below the radar.