Large Fund or Small

chiang_mai

I'm told by local "experts" to avoid large funds and that smaller funds tend to be more nimble and readily able to change tack in times of crisis - for the purpose of this question, let me suggest that a small fund is defined as something around GBP 400 mill. or less whilst larger is defined as GBP 1 bill. or more.

It sounds sensible but is it true or false?

Linton

Do you want a fund that changes tack in times of crisis? Better in my view to have a strategy and keep to it.

A more important factor would be that very large funds are limited to large investments. A £100M fund could consider investing in a higher risk/higher return £1M opportunity. For a £4B fund it would probably not be worth the effort. This is a particular consideration in small company and high tech funds.

bowlhead99

The answer is probably "it depends".

Let's say your fund is £300m in size and has a strategy of holding a concentrated portfolio of equities in no more than 30 companies which the manager has researched and deems worthy of inclusion. On average, each position will be £10m in size although he will prefer some holdings to others and some will have performed strongly so he mayhave some positions at £30-40m and others only in the £2-5m range.

If the fund manager's strategy is to invest into smaller companies whose total enterprise values are £40m to £1bn, then his £30-40m stakes are between 3% and 100% of the entire company he wants to invest in. Clearly he is not going to be very 'nimble' if he owns 3%+ of the entire company which is a notifiable position and could be several times more than the average daily traded volume on the stock exchange. And if he wants to own a £40m in a £40m company - well, that's just not going to go. Even £4m in a £40m company is a relatively large and illiquid stake and you could be the biggest investor in the whole company. For some specialist funds a 10% stake could be fine and part of the game plan (with potential of influence over management etc), but for most it would not be due to the illiquidity.

So, in that situation even a £300m fund could find it tricky to deploy capital in line with its strategy and a £1bn or £5bn fund would find it much more difficult or impossible.

By contrast, a £1bn fund which wants a broad and diversified portfolio of 60-100 positions and is mostly looking to invest in US or globally-focussed largecap shares. It could sell down a $20m position in $800bn Apple Inc over a couple of days without anyone batting an eyelid. So the absolute size of the fund is not a barrier to it doing business and there is no liquidity problem even though the fund is larger than the £300m fund we discussed earlier.

You mention the question of whether the fund can 'change tack' in times of crisis. Often it is not simply the size of the fund but its stated investment objective. If it is a fund like Blackrock Gold and General which is marketed to investors as investing in natural resources stocks (gold and commodities) and there is a dramatic global change in the level of demand for metals and minerals, it can't simply decide it wants to go and invest in healthcare or UK commercial property, whether or not its existing holdings are small enough to be 'nimble'.

If your fund has a gameplan to invest in Japanese smallcaps then being small is useful because when you duck out of one holding you have to be able to do that and get into another relatively painlessly, so the smaller the stake the better, even though you are still going to be exposed to the Japanese economy and currency issues etc just like you've promised your investors. Whereas if it was a global mixed asset fund then it could change its asset allocation between asset classes and industry sectors on a whim - in which case you would expect it would probably have a much more flexible set of international investments to choose between and redeploying a large chunk of capital could be quite easy.

Only having a small amount of capital to deploy is on one hand an advantage for managers because they can easily fit their orders into the orderbook and buy or sell into a reasonable timescale. However, on the other hand, smaller funds are more costly to run. Doing trades for $10,000 a time can be quite inefficient as your broker would charge you a higher commission rate on selling $10,000 rather than selling $1,000,000 or $10,000,000. And if the fund is getting charged annual administration costs, audit costs, legal costs, annual meeting costs etc, those things work out at a lot more expensive per pound invested if it's a £100m fund instead of a £10bn fund.

Likewise it is horrendously inefficient spending a week of fund manager time deciding to start building a stake in a target company with a $500k investment for your small fund when a larger fund making the same decision would be doing a $5-$20m initial stake.

So you would expect higher management fee and OCF in a smaller fund which can gradually erode capital - if the manager isn't able to make back that money with clever 'nimble' deals like the £1m opportunity that Linton suggested (which wouldn't be on the radar of a mega fund because it wouldn't move the performance needle).