Asset Allocation Helps Manage Large Funds

Hemant Rustagi
CEO, Wiseinvest Advisors

It is always a good idea to invest in funds that have done well over a long period. The long-term consistent performance track record of a fund confirms its ability to perform well over different market cycles. However, a fund with a long-term track record usually grows too large in size. Unfortunately, the size of the fund often puts investors in a dilemma with respect to its future prospects. Let’s see if the size of a fund should stop investors from investing in it.

While a fund can become unwieldy to manage efficiently if it grows too large, it may not be a disadvantage for all types of funds. The impact of the size of a fund on its performance would depend upon the asset class it invests in as well as its investment strategy/philosophy.

For instance, in case of a pure large-cap fund or a multi-cap fund that invests pre-dominantly in large-cap stocks, the size of the fund may not matter much. That’s because these stocks are quite liquid and hence buying and selling them in any quantity is not a problem for a fund manager. Similarly, the large fund size may not have any impact on debt funds like liquid fund, ultra short-term, short-term and even income funds.

However, a fund’s performance can suffer in case it outgrows its investment style. A mid-cap fund where the success depends on how effectively the fund manager picks stocks, the large size of the fund may force him to compromise the quality of stocks and the liquidity. This segment of the market remains under-researched and hence there aren’t too many opportunities here. However, considering the potential of mid-cap companies to do well, these funds do attract large sums of monies when the markets do well. In a way, these funds become victim of their own success at times. Similarly, if a sector fund becomes too large, the fund manger may struggle to invest the money in the sector efficiently.

From investors’ point of view, they can ignore the fund size while investing in large-cap or large-cap oriented multi-cap funds and just focus on the fund’s investment strategy, quality of portfolio and long-term performance track record. In fact, investors benefit from lower expense ratio when they invest in large funds. However, the fund size can be an important consideration while investing in mid-cap, value or sector funds.

Another challenge for investors is to find a balancing point which can ensure that their portfolio risk remains within their risk taking capacity. The right way to do so is to follow an asset allocation strategy as it combines various asset classes such as equity, debt, real estate and commodities into a portfolio.

Retail investors generally find the process of asset allocation slightly cumbersome and hence often look for easier solutions. This is the reason why many retail investors believe that a capital protection plan provides answers to their needs of asset allocation and balancing risk and reward.

A Capital Protection Plan is a fund that aims to protect the capital by investing pre-dominantly in fixed income instruments and generate capital appreciation by investing the balance in equity and equity-oriented instruments. For example, a three-year capital protection plan would typically invest say Rs 80 in debt instruments out of every Rs 100 collected and the balance of Rs 20 in equities. At the expiry of the scheme, the debt portfolio would in all probabilities grow to Rs 100 or little more, thereby protecting the capital.

Although a capital protection fund allows investors to diversify between debt and equity, there are a couple of drawbacks too. First, these are closed end funds and hence an investor would require a lump sum to invest. Second, in the absence of a continuous investment process, an investor neither gets an opportunity to invest regularly nor benefit from ‘averaging’, which is the key to the equity portion of the portfolio.

It is quite evident that as an investment option, a capital protection plan has a limited utility. Therefore, retail investors must focus on the asset allocation strategy to maintain a right balance between risk and reward and invest in a combination of investment options that allows them to benefit from higher transparency, flexibility, variety and tax efficiency of returns.