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White elephants?

Few investors take into account the size of the funds they are looking to buy although a growing body of IFAs believe this is an oversight which can leave investors with funds which fail to match their expectations.

But there is no consensus over which are better – small or big funds.

Hargreaves Lansdown believes that small funds tend to outperform when married to good management. To make its case, HL points to the all companies sector. According to Lipper, eight of the 10 best-performing funds in the sector are less than £25m in size while the bottom 20 funds include nine above £100m, featuring giants such as Scottish Life&#39s £1.4bn UK equity fund and the £1.2bn Abbey National UK growth fund.

HL head of research Mark Dampier says: “If you have a good fund manager with a small fund, it will usually do well. It is a potent mix. Plenty of funds start off brilliantly after launch but then struggle as they hit the £60m-70m mark, often forcing them to move up the cap range. It can hinder their ability to manage.”

Dampier particularly rates the UBS UK smaller companies fund, currently less than £10m, and Invesco Perpetual&#39s UK recovery fund, which is barely more than £2m. As newly launched funds, neither has a track record over one year, which means they are not on the buy lists of IFAs reluctant to recommend funds without proof of consistently good performance.

Dampier says this screening process is “completely insane” as it means investors often miss a fund&#39s best years. He believes the lack of a track record is no problem for a fund as long as its manager has a good performance history with other funds.

Dennehy Weller managing director Brian Dennehy says he would not consider recommending a fund of less than £25m because of the risks involved.

He says: “Funds under that size are wholly inappropriate to most investors because the reality is that many of them are being run by one man and his dog as a hobby. They do not have the support of the bigger funds.”

Dennehy makes a point of monitoring the performance of funds over his preferred size of £400m. Of the 40 funds that fall into this category, he says 19 have outperformed their respective indices over the last three years.

He believes big funds benefit from the scrutiny they come under by IFAs, investors and the press, who tend to slam underperforming funds which have thousands of investors. Dennehy also suggests that the lack of liquidity in bigger funds is not a problem because the managers “tend to get it right first time, every time”.

Fund manager Patrick Evershed used to run Framlington&#39s capital fund when it was around £125m. But years later, when he moved from Rathbone Unit Trust Managers to New Star, where he now manages the select opportunities fund, he insisted that his new fund should be capped at £50m. Rathbone had been allowing investors in his old special situations fund to transfer to New Star free of charge, encouraging a flood of investment.

Evershed says: “As long as I am getting an idea every week or 10 days, I can cope with small amounts of money coming in. Anthony Bolton has done this for years and his fund has grown to £1bn. But if you get tens of millions of pounds all of a sudden, it is difficult to find enough ideas to invest the money.”

Evershed believes the liquidity problems faced by managers with big funds are largely mitigated by the fact that brokers take monolithic funds – which generate hefty commission – more seriously. Nevertheless, he says funds become more difficult to manage when they hit £200m, regardless of broker input.

Perhaps multi-managers are in the best position to judge whether small or big is better. Credit Suisse Asset Management believes there has been a shift in the attitude of the big houses to make retaining existing assets under management their number-one priority.

Joint head of multi-manager Gary Potter says: “The dominant attitude now is, let&#39s not take too much risk, let&#39s just take the index-plus approach. It is not fair to say that big funds cannot outperform – look at Anthony Bolton&#39s and Roger Guy&#39s at Gartmore – but it is easier for smaller funds to generate good performance.”

CSAM&#39s top 10 positions reflect this, with funds from Liontrust, Thames River Capital and JO Hambro beatingfunds from the bigger houses. Potter says CSAM is currently biased towards sma-ller companies with small funds – a situation he sees contin-uing for the foreseeable future, as he fears that most big funds will regress to the mean or worse.

Although the market appears to be favouring smaller funds, there are sizeable funds performing well. But the fact that these tend to be run by the heavily incentivised big hitters who maximise the resources which have been tailored specifically to their requirements indicates the problems that beset such huge funds. David, for the time being at least, is beating Goliath.


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