Does the size of an investment fund impact its performance and are you losing out because of it?
I have read countless studies on this and the two main studies conclude the reverse of each other.
Neil Woodford’s fund at Invesco was one of the earliest funds to face this criticism as it reached over £20bn. In that instance it was his big bets going wrong, along with a stray from his discipline that affected fund performance, rather than the fund size itself.
Fundsmith is another example today at £18.3bn in value. Over the last five years it has attracted over £9bn in new funds. The investment fund has returned over 70% in the last three years, and 358% since its launch in 2010. Impressive stuff if you are invested there.
To give that some perspective, that’s 19.2% per year return on average, versus the benchmark of 12%. Over the last five years it has returned way more than double the global average.
Naturally that would allay any fears about size having a direct impact.
For sure you might think that a fund with nearly £18.3bn might struggle to sell off some of its stock if it needed to take gains, or even move away from a stock because of market conditions, but this fund invests in highly liquid and large capitalised stocks, so that risk is also diluted.
Fundsmith has a buy and hold approach with its stocks which involves picking well-researched stocks and keeping them. However, if and when it decides to take profits from a stock or even sell it, there would clearly be an impact on the price of that stock, as it was selling it down, as the market would see those trades happening, and naturally the unwanted stock’s price would immediately fall.
Could a large manager move that amount of money without having an impact on the price as it was doing so? Not really.
The current market suits the above fund but market conditions aren’t always this way, and at some point, flexibility will be lost in terms of the amount of investments available to the manager to invest into.
Investors invest knowing that the manager is staying close to a proven strategy or a process or a method that works.
The risk comes when performance wanes and a manager alters the above process and strays into unchartered waters in search of the performance. It is more comforting to an investor to know a manager is sticking to what they are good at even if they are under-performing, rather than becoming a maverick and ditching a process.
When the Blackrock UK Absolute fund grew quickly and then began under-performing, its manager was jailed in 2016 for insider dealing. His lawyer said the illegal trades he made were done when he was in ‘mental freefall’ when trying to deal with that under-performance.
The style of the manager is key to whether or not the size actually matters. A fund investing into small stocks needs to be nimble and able to trade in and out quickly, whereas a large fund investing in such stocks would be the equivalent of a supertanker without manoeuvrability.
There are a limited number of companies who can support a large investment so there can come a point that a manager is forced to buy other stocks due to the limitation. This can dilute performance as the manager strays from their area of expertise.
Whilst not in the case of Fundsmith so far, the size of the fund means the manager becomes limited to larger liquid stocks which of course are all well researched and ‘reported on’ stocks. As such, their price remains constant as there is little or no surprise inside there and no real space for you to buy a ‘bargain’ and see your price rise.
One final risk is in some older funds where managers are incentivised on fund size. This motivates the manager to attract new money and then move into more benign, protected stocks to safeguard the fund size which in turn creates under-performance.
About the author
Peter McGahan is Chief Executive of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
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