When considering the merits of investing in a certain fund, there are many aspects to think about. One aspect often overlooked is the amount of assets being managed.
It can often be easier for a manager of a small amount of assets to be flexible and perform well.
At first glance this sounds simple, but in reality there are often complications, including the push-pull dynamic of commercial viability and asset growth versus the desire of the fund manager to ensure the portfolio remains liquid and flexible.
This is not to say that all large funds make bad investments. Some managers have developed a successful investment process that is contrarian and long term, so managing a larger amount of assets is less of an issue, given that they will tend to be buying when others are selling, and vice versa. Therefore, it is important for the fund buyer to understand the manager’s investment style and approach.
It is also vital to consider the type of assets being invested in. The size of the asset base is less important when investing in large-cap equities where the market is broad and deep.
However, when investing in asset classes such as small-cap equities and corporate bonds – where liquidity can be challenging at the best of times – it is important to ensure the fund buyer is comfortable that the manager has a good sense of their capacity in asset size.
This is so they can maintain the same investment style and level of flexibility that has delivered the performance which probably piqued the fund buyer’s interest in the first place.
Consider a small-cap fund manager running an equally weighted, focused portfolio of 40 stocks who has performed well for three years – often the period investors require to gauge consistency.
If that manager had achieved that strong performance with an asset base of £100m, each position would be £2.5m set against an average market cap of the FTSE Small-Cap index of £246m.
If, after this strong performance, assets gather pace and the fund grows to £800m, each position is now £20m – meaning the fund manager owns a considerable stake in each business within the portfolio.
At this stage, the fund manager has two choices: Accept the illiquidity of the portfolio and try to manage any outflows the best they can, although any meaningful redemption from the fund would mean the manager is selling against themselves. This situation can lead to a vicious circle with the manager hitting the bids of their own stocks to raise money.
Or, let their investment style drift – increasing the number of names in the portfolio and meaningfully changing its construction.
This is likely to be a different portfolio to the successful one that attracted the assets after the first three years – resulting in those who come late to the strategy getting more of a core proposition with less alpha potential.
This is an extreme example in a reasonably illiquid asset class but it can happen.
However, it can be avoided. If the manager has a realistic view of capacity and the ability to control it, they can continue to implement the same successful strategy over the years ahead.
Rob Burdett is co-head of F&C Multi-Manager
