The Signal: Assets Under Management – An Asset or Liability?

Many investors view a high AUM as a virtue while an equivalent number of investors consider it a liability. However, the truth lies in somewhere in between.

High AUM while selecting an equity mutual fund – Pros, Cons & Caution

At the outset, one must understand that a high AUM is a factor of fresh inflows (consistent fund performance, distribution strength, sales & marketing prowess, brand equity are important vectors) and appreciation of invested fund value. A large part of increment in AUM of most funds can be attributed to fresh inflows.

Now, high AUM could be an asset when it comes to having access to market deals with high minimum bid levels or gaining access to management of larger corporates. Often, large AUM funds also have a long vintage and benefit from processes developed basis learnings from multiple cycles. These funds also typically benefit from deep institutional depth and best practises in fund management, for which smaller (and relatively new) funds are yet learning the ropes.

However, this does not mean that one can pick any large-sized AUM and expect it to do well. To offer perspective, out of the top five funds sorted by 10-year trailing performance, one fund’s AUM is less than 1,000 Crore, one more than 20,000 crore and three in the range of 10,000-20,000 Crores.

A correlation exercise between performance and AUM done across key equity categories also does not reflect a strong correlation. Hence, would be safe to conclude that AUM, while is an important hygiene criterion, is not as effective as an evaluation parameter.

Risks associated with extremely high AUM

A popular belief is that as the AUM of a fund increases beyond a threshold, it becomes difficult to deploy in strong market opportunities – this is majorly because of a notion that Indian capital markets offer limited opportunities at any given point and can absorb only limited capital.

While this may be true in some cases, it does not apply across the board.

For starters, let us put things into perspective. The AUM of the largest large cap fund is ~INR 20,000 Crore and the largest stock’s market capitalisation is ~INR 11 Lakh crore. In fact, the mutual fund industry’s equity AUM is ~INR 9.5 Lakh crore – less than RIL’s market capitalisation. So, for most of the equity mutual funds, there is enough and more liquidity and market opportunity.

Exceptional cases where AUM could matter more than the rest

Smallcaps. The investible universe of smallcap funds consists of stocks with very small market capitalisations. For context, market cap of the largest small-cap stock is ~7,000 Cr. and the AUM of the largest small cap fund is also the same. Here, a large AUM could lead to a couple of problems. 

While the small cap universe has a greater number of stocks than large and mid-cap, the number of high quality, investible small cap stocks are very few. 

A large AUM cannot be continuously deployed into the same set of stocks since it could lead to owning a majority stake in the company (not allowed by the regulator; also increases liquidity risk) or could be lead to increased ‘cost impact’ – where a fund’s transacting in the stock causes the prices to move erratically sheerly because of volume.

Debt funds. A single-phrase guidance on debt funds’ AUM would be to “avoid the extremes”. Given the nature of debt securities, average minimum subscription prices of debt securities and the depth of the Indian fixed-income market, a larger AUM could leave the fund vulnerable to excessive redemption pressure while a smaller AUM fund would not be able to negotiate better rates with issuers. The sweet spot is somewhere in the middle.

Arbitrage funds. Arbitrage funds exploit market mispricing. As Indian markets move from being semi-efficient to efficient, the coverage increases and the quantum of mispricing opportunities is expected to reduce over a longer period, albeit gradually. At the same time, a dramatic increase in money chasing limited arbitrage opportunities could take a toll on fund performance. But this has more to do with the category AUM than a fund’s AUM specifically.

Key takeaways for investors

AUM is an important hygiene metric to ensure that the fund has experience in managing scale and be assured that it is probably being tracked by more analysts and investors – reducing the probability of any questionable decision going under the radar.

At the same time, the quality of portfolio has a higher correlation to performance than fund size to performance. Except for a couple of categories like smallcap, arbitrage and debt funds one need not lose sleep over deciding a better fund basis AUM.