Investors chase the past performance of mutual funds, , as everybody wants a piece of the pie. As a result, you will see funds that have put up a spectacular performance in the past, grow their corpus exponentially. Thanks to aggressive marketing campaigns and promotions by the fund houses to showcase the past performance to get more investors.
At present, there are as many as 11 equity-oriented schemes that have gathered a corpus above Rs10,000 crore. Several of these funds achieved this feat in the bull market rally of the past year. With a combined corpus of a whopping Rs1.60 lakh crore, the top 11 equity schemes out of 425 (That's just 3% of the total number of funds) account for nearly 30% of the total equity assets.
While fund houses celebrate their growing assets and entry into the Rs 10K-crore club, investors tend to become cautious when their funds balloon in size.
The common perception among industry experts and some investors is that performance suffers as the fund increases in size due to liquidity constraints. Due to this, the fund managers happen to diversify over a number of stocks or make a shift towards highly liquid large-caps and larger mid-caps. However, fund houses and their managers will hotly dispute this contention.
PersonalFN is of the view that the key to fund performance lies in its investment style, which is also a factor of the fund manager's experience and investment processes followed by the fund house.
PersonalFN takes a deeper look at how the growth in assets of a fund tends to affect the investment approach and how this may translate to a divergence in performance.
We look at five large sized equity-diversified funds that have delivered a stellar performance over the past few years, which in turn carried them to the Rs10k crore club. The list includes Axis LT Equity Fund, Birla SL Frontline Equity Fund HDFC Mid-Cap Opportunities Fund,ICICI Prudential Value Discovery Fund, and SBI BlueChip Fund. We have picked from the best performing funds of different fund houses and those that maintain a varied investment style and mandate. None of these schemes have gained AUM on account of mergers over the past five years. Let's have a brief look at these schemes.
Growth in AUM
(Source: ACE MF, PersonalFN Research)
As you can see in the past five years chart above, these five schemes have reported tremendous growth in Assets under Management (AUM) . Schemes such as Axis Long Term Equity and SBI BlueChip started out in 2011 with a corpus of approximately Rs 137 crore and Rs 693 crore respectively. HDFC Mid-Cap Opportunities and ICICI Prudential Value Discovery had a corpus of around Rs 1,500 crore each, while Birla SL Frontline Equity had a corpus of Rs 2,800 crore.
Performance - Past 5-year Rolling Returns
(Returns are compounded annualized. (Source: ACE MF, PersonalFN Research)
In terms of performance, these schemes have not disappointed. All have handsomely beaten their benchmarks. Axis Long Term Equity, HDFC Mid-Cap Opportunities, and ICICI Prudential Value Discovery did better because of their higher mid-cap allocation in the initial few years. Birla SL Frontline Equity and SBI BlueChip invested predominantly in large-caps throughout the period; hence, returns are a few percentage points lower. Nonetheless, they have done well to outdo the market benchmarks.
Now bringing back our focus to the growth in fund size…
…the growth in AUM results in three main changes in the portfolio. Let’s take a look at each of these below:
Number of stocks
As the fund’s corpus grows, the fund manager may start deploying capital into new stock ideas, as the potential to scale into existing stocks is limited due to liquidity constraints. Thus, if the fund initially had a concentrated portfolioof mid-cap stocks, the number of stocks is likely to increase as the AUM grows.
Because of this, the fund manager’s attention per stock position would decrease. This may also mean that lower conviction ideas may trickle into the portfolio and ultimately, lower performance. More the number of stocks may mean a higher probability of missing important details about the trade itself.
In the historical holdings of the five funds over the past five years, Birla SL Frontline Equity and HDFC Mid-Cap Opportunities increased the stocks in their portfolio from 65 to 75 and 60 to 80, respectively. The holdings of Axis LT Equity 40 stocks and SBI BlueChip 50 stocks have remained practically unchanged. Surprisingly, the holdings of ICICI Prudential Value Discovery reduced from about 65 to 40 stocks. We’ll look at the reason behind this a little later.
Number of Stocks in the Portfolio
Returns are compounded annualized. (Source: ACE MF, PersonalFN Research)
Average market-cap
As the AUM grows, fund managers may start moving in stocks with higher market capitalizations.Stocks with a higher market cap tend to have better liquidityand allow fund managers to invest a higher quantum of assets. Thus, as the corpus grows, the average market cap of the portfolio increases to maintain the same level of liquidity. While the manager may do well in this new market capitalization segment, it may be an uncharted territory based on its previous track record.
HDFC Mid-Cap Opportunities and ICICI Prudential Value Discovery were both mid-cap oriented schemes. The mid cap scheme from HDFC Mutual Fund now maintains a significant portion of its portfolio towards large caps and higher mid-caps, along with diversification into mid-& small-caps. However, ICICI Prudential Value Discovery has transformed into a multi-cap scheme with a large-cap bias. This explains why ICICI Prudential Value Discovery has been able to reduce the number of stock holdings. The scheme can now invest a higher proportion in large-cap stocks without compromising on liquidity.
Axis Long Term Equity, maintained an equal mix of large-caps and mid-& small-caps. The fund has now moved from small-caps to large-caps with the mid-cap allocation remaining the same at around 30%. Birla SL Frontline Equity invests predominantly in large-caps with the allocation increasing from 72% to 80% over the past year. SBI BlueChip maintains an allocation of around 70% to large-caps. It’s the only scheme that has not increased its large-cap allocation as compared to the other large sized schemes.
A Shift to Large-caps
(Source: ACE MF, PersonalFN Research)
Liquidity
If the fund manager does not increase the number of stocks in the portfolio or if he has not shifted to higher market-cap stocks,he maybe compromising on liquidity. However, if a fund is predominantly large-cap, there may not be much change in asset allocation as it may already be fairly liquid. This is evident in SBI BlueChip that has kept the same number of stocks, with the large-cap allocation unchanged. At the same time, it is important to note that the fund manager still maintains slight allocation of upto 10% in mid-caps and the remainder into cash.
Also, if the manager derived most of its past performance from tactical trading, exploiting that skill under lower liquidity constraints may not be possible without significant trading costs, which would ultimately impair net returns. Therefore, as the corpus grows, the fund manager would look to move to a buy-and-hold, rather than actively churning the portfolio.
As an investor, what do you need to do if your fund's corpus has grown significantly?
At what point of AUM growth does it make sense to start worrying about a manager's capability to sustain returns moving forward? If the performance deteriorates, it may already be too late. What should you do?
You need to check whether AUM growth is causing changes to the investment style. Some changes may be in the interest of the investors and some may not. Act before any changes materialise as disappointing performance. Many investors pick schemes solely based on past performance which may not be achievable with the change in investment style.However, you need to take a deeper look. Stick to your fund if you are comfortable with the new investment mandate and are ready to tone down on your return expectations or else move out.
Judging a mutual fund scheme solely based on its AUM size is rather absurd. Yes, we call it absurd because the ability of the fund in sailing through market cycles, is a function of its stock picking exercise, that's reflected through the investment processes and systems followed by the fund. It is also a factor of the fund manager's experience. There is little evidence that substantiates the claim that fund performance will deteriorate with the growth in the fund's corpus.
Mutual fund performance ranking and ratings are now easily available, yet these rankings and star ratings can often be misleading At PersonalFN, we follow stringent research processes that focus on both quantitative and qualitative parameters to enable you to select solid schemes that have the potential to generate 'market beating' returns
Remember, it's your hard-earned money you are investing in mutual funds with the objective of wealth creation. Choose wisely.
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