Fund Size Doesn't Affect Performance Size doesn't matter after all.
September 29, 2003
That was the conclusion reached by a team of researchers at mutual fund tracking firm Lipper of New York, after carefully studying the relationship between fund size and performance.
In a recent study entitled "Does Fund Size Affect Performance?" Lipper analysts were tasked with examining whether it makes sense for retail investors to screen funds according to their total number of assets under management. The results of the study were somewhat surprising because they go against the conventional wisdom of mutual fund investing.
The prevailing school of thought about funds with large asset bases has always been that they can't perform as well as smaller funds because their managers tend to be stuck with a short list of big stocks that can accommodate their assets but cannot move as swiftly when shifting their positions. For example, if a fund bought or sold a huge chunk of shares in one security it would incur price impact and execution costs that would drag down performance. The idea is that once a fund has amassed a large number of assets it loses its flexibility.
However, Lipper applied a different methodology, one that managed to eliminate the perceived performance advantage. It didn't find any consistent evidence that fund size erodes returns. In fact, the company concluded that fund size does not affect performance in any real way.
"We found that there is no consistent benefit to being in a small fund versus a large fund," said Andrew Clark, a senior research analyst at Lipper and author of the report. "Many financial advisers steer clients away from big funds out of fear that liquidity concerns will drag down their returns, but we found that fund size frankly does not matter."
Clark believes that larger funds often have benefits that smaller funds don't have, such as better research and resources, lower expense ratios and the ability to get their hands on initial public offerings. These benefits enjoyed by the bigger funds compensate for any of the disadvantages spawned from liquidity constraint, he said.
The study was based on the performance of approximately 450 actively managed U.S. diversified equity funds between 1991 and 2001, including core, growth and value portfolios. Breaking down the numbers, Lipper examined one-year returns from 1991 to 2001, three-year returns from 1993 to 2001 and five-year returns from 1995 through 2001. Bond funds and international funds were excluded from the survey. Mixed equity, equity income and sector funds were also excluded because there wasn't a large enough sample of funds to insure statistical significance.
The funds' returns were measured in one-, three- and five-year periods over the 11 years, based on gross returns and net and risk-adjusted returns. In the case of gross returns, there was evidence of small funds outpacing large funds during a particular time frame but that dominance was not sustained over multiple periods.
"When it comes to gross returns, we do not find a single case where fund size drives performance in any contiguous one-year, three-year or five-year period," Clark said.
On a net and risk-adjusted basis, there were three- and five-year periods where larger funds actually beat smaller funds. However, when divided into large-cap and small-cap portfolios, that edge disappeared. It is important to note that even when small funds beat large funds or vice versa in a contiguous period, they never beat the other fund size in the next contiguous period. Therefore, the study demonstrates that an investor cannot exploit the differences in returns, not to mention the inconsistency of the outperformance.
"Our findings lead us to conclude that for the retail investor, there is probably nothing to be gained by filtering on fund size," he said.
Meanwhile, Lipper plans to release a second part to its study on fund size that explores whether optimal asset sizes exist for mutual funds. Early indications reveal that there is indeed an optimal size for funds but the results are not as relevant for the individual investor as the first report.
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