Concerns about liquidity risks and the closure of a number of funds have reignited the debate around the importance of size. But just how big is too big?
Large flows into funds force managers to invest in more securities. This reduces their ability to take “punchy” active positions and add alpha through stock selection, argues Thomson Reuters Lipper head of UK and Ireland research Jake Moeller.
Hargreaves Lansdown senior analyst Laith Khalaf adds: “If you are running £30bn of client assets then if you think about investing 1 per cent of that amount you are talking about investing £300m.
“That is more than some companies are worth, so it reduces your opportunity set.”
Moeller also says although the link between large size and performance may be “tenuous”, there is likely to be liquidity ructions even in the safer space of investment-grade credit.
During the summer, investors pulled £2.7bn from Richard Woolnough’s M&G flagship Optimal Income fund in three months after a decline in performance resulting from cautious positioning.
The bond fund shrank from £23.8bn in March to £20.9bn at the end of June, according to Morningstar.
Woodford Investment Management star fund manger Neil Woodford, who used to run a £33bn income fund for Invesco Perpetual, argues size is not an inhibiting factor when investing.
He says: “I don’t know when ‘x’ is too big but you could trust me to make that judgement because it is in my interest to make sure that I continue to deliver good investment performance on behalf of my clients. I’ve run very good funds before. When I left Invesco I was running massive funds, but not all fund managers will have the same view.
“Different fund managers with different approaches would find £33bn a ridiculously large sum of money to try to be managing and deliver performance. But the scale of the fund has to be seen in the context of the fund management approach and style, as well as motivation.”
But Khalaf argues that large holdings in big funds raise dealing and liquidity issues.
He says: “If you think about Neil Woodford [when at Invesco Perpetual], 6.5 per cent of your portfolio is GlaxoSmithKline, and if you are running a £30bn fund then you’ve got almost £2bn in Glaxo. In that scenario what happens if you change your mind and decide to sell that stock and buy something else? You’ve got to sell £2bn worth of stock and that is more difficult than selling £1,000.”
Experts say a fund could become “too big” because of the nature of the underlying investments.
Moeller says small or mid-cap funds are more difficult to manage at a larger size because these stocks are less liquid.
Khalaf says: “If you look at small cap funds at around the £1bn mark you probably start to encounter problems. A lot of funds do actually tend to soft close at that point.”
According to Moeller, £500m is often cited as “too big” for mid-cap equity funds.
This year, TwentyFour soft closed its Dynamic Bond fund at £700m, R&M soft closed its UK Smaller Companies fund at £550m and Kames soft closed its Absolute Return Bond fund at £1.7bn.
Khalaf says the smaller the fund, the easier it is for the manager to run it. He adds: “You don’t want the fund to be so small that the fixed costs of running it are proportionally too big”.
The number of stocks within the fund is also a factor to consider, according to experts.
“If it is a concentrated fund in small caps you really can’t run that much money and we get concerned when stocks in a large fund are between 30 and 50,” says Chelsea Financial Services managing director Darius McDermott.
Morningstar director of manager research Jeremy Beckwith says funds that can be very big are the ones invested in the largest companies or government bonds, which benefit more from macro strategies.
He cites the Stewart Investors Asia Pacific fund, an all cap fund which was closed and then relaunched as the Asia Pacific Leaders fund. Beckwith says although the new fund followed a similar strategy, “it was much more built on blue chips stocks so you could get more money into it”.
Experts argue management style is what counts when dealing with large funds. McDermott says: “The fund size broadly is an issue, as some groups are better than others at sticking to the right strategy.”
He cites the £496.3m Marlborough UK Micro-Cap Growth Fund, which has a diversified portfolio with 250 stocks.
AJ Bell investment director Russ Mould says if big funds are building positions for the long term to generate income on a sustainable basis they will not necessarily encounter liquidity problems.
He says: “It would matter a lot where you invest and what you are investing in.
“The M&G Optimal is a complex beast, for example, but it is clearly taking directional positions and yet Woolnough has a mechanism for managing that because at the moment the performance has been very good. Directionally they’ve been short duration, which has worked out pretty well this year.”
Columbia Threadneedle head of UK equities Leigh Harrison adds: “The way that you try to run the money is the most important thing. In terms of strategy, you start thinking about the level of total return between dividend and capital growth. You can run a lot of money if you think about what you are doing.”