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KUALA LUMPUR: When evaluating a fund, investors look at factors such as the credibility of the fun...

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KUALA LUMPUR: When evaluating a fund, investors look at factors such as the credibility of the fund manager, the fund’s risk exposure and its
outlook. Few bother about its size (assets under management or AUM).

But size does matter here. The size of a fund can affect its ability to react to the market and, ultimately, the returns that it makes.

Here, fund management experts discuss the advantages and limitations of small funds.

1) What is small?


There is no official definition for a small fund. Whether a fund is considered small depends on its fund category and the country’s capital market. In the US, funds with asset bases of under US$500 million, some of which came up tops in the three-year period at the 2011 US Lipper Fund Awards, are regarded as small.

In a much younger market such as Malaysia, funds are much smaller. For instance, research data company Morningstar Asia excludes funds with
an AUM of RM20 million or less from its annual Morningstar fund awards.

“They [funds of this size or smaller] cannot stay this small since they are not economically viable to run. It is not as if their small size offers an ongoing benefit to investors,” says Christopher Traulsen, director of fund research for Europe and Asia at Morningstar Europe.

As at end-January, there were 166 local funds with AUMs of less than RM20 million. However, industry observers and fund managers regard many more funds as small.

Danny Wong, CEO of Areca Capital, says equity funds with an AUM of less than RM10 million or bond funds with an AUM of less than RM20 million are deemed small. But he goes on to say that the smaller pool of money that a fund manager has to invest does not mean that returns would be affected.

“For some types of equity funds, especially those that invest in growth companies, RM5 million is workable. There is the management expense ratio [MER] to think about but the performance of the fund should be able to exceed this cost. Small-cap funds work well with a small AUM. Typically, to make a meaningful investment, 5% of a fund’s AUM should be in a single stock.

"A fully invested fund needs at least 20 companies [in its stable] for it to be considered diversified. If a small-cap fund has an AUM of RM1 billion, it is essentially investing at least RM50 million in one stock. Since some small-cap companies have a paid-up capital of only RM50 million, the fund manager is the major shareholder,” says Wong.

So, what is the ideal fund size? Fund managers have differing opinions but the figure seems to be between RM10 million and RM500 million for equity funds and between RM30 million and RM100 million for bond funds. A “bigger” fund has a reduced overall cost, explains Gan Eng Peng, head of equities at HwangDBS Investment Management Bhd.

“From a fund manager’s perspective, there are three key considerations for an ideal fund size: investment, business viability and cost. For example,
if a fund’s mandate is very specialised and requires dedicated research and resources, then a larger fund size will balance this cost.

"On the other hand, if its mandate is very similar to an existing fund, the fund can be managed in a similar fashion. In such instances, a fund size of at least RM1 million will suffice [in terms of business viability].”

2) More nimble when small

Small funds are known to be more nimble when responding to drastic changes in the market. Such funds are easier to manage, says Robbin Khoo, CEO, Inter-Pacific Asset Management Sdn Bhd.

“Small funds are inherently flexible and agile. This is not the case for a multi-billion-ringgit fund. Given the size of the underlying market, moving a fund of this [large] size is more difficult.”

On the flipside, a small fund may be unable to capitalise on buying opportunities due to lack of sizeable assets. This is regarded as a key disadvantage. “This could happen either through the unavailability of funds, or the regulatory constraints that prevent funds from investing more than 10% of their net asset value [NAV] in a single security.

"While it could be easier to manage smaller AUMs, it doesn’t mean that it is easier to make returns. A small fund faces the same challenges as a bigger fund.”

But whether a small fund’s agility and limited investment universe affect its performance boils down to the fund manager. Gan has found the performance of one (small) fund to be very different from another (small) fund, although both share similar mandates and are managed by the same fund house. This disparity is due to the skill set of the respective fund managers — their teams, style, capabilities and experience.

“For example, smaller funds are managed by a smaller team or less experienced fund managers while the more experienced fund managers manage the more commercially important and bigger funds. This is why performance drastically differs from one fund to another, despite [having] similar mandates. In addition to that, a departure of one fund manager can bring about a major change in investment strategy; thus affecting performance,” says Gan.

To address this situation, some fund houses use a model portfolio method whereby the managers pick investments that are then used in all
their funds, subject to the fund’s mandate. This ensures that the funds are not left out when a good investment is found.

3) Margins for smaller funds are smaller

A fund needs to cover the costs of running a fund, such as its MER and trading costs. These expenses eat into the fund’s returns. Some costs are calculated based on a percentage of the AUM (the smaller the fund, the lower the charges) while other charges are absolute.

“The trustee fee is 0.08% of a fund’s NAV, or a minimum of RM18,000 a year. Audit fees are typically around RM5,000, taxation fees range
from RM2,000 to RM3,000. Don’t forget the cost to print the fund’s annual report, which can be between RM1 and RM1.50 each,” says Wong.

This implies that small funds can be burdened with higher operating costs relative to their bigger peers. According to Wong, investors can determine if an equity fund has a high operating cost by looking at its MER.

“An equity fund of any size should have an MER of less than 2%. The MER for a bond fund should have a lower operating cost, so if it has an MER of above 1.2%, it is considered high. For money-market funds, MERs should range from 0.7% to 1.2%.”

4) Small funds carry a higher risk of liquidation

When the size of the fund is too small, high operating costs can threaten its viability. In such a situation, the small fund is more susceptible to liquidation or mergers. “When small funds become too small to operate effectively, their fund managers will have a moral obligation to restructure them. These funds are generally those with an AUM of RM5 million or less. [The fund manager has an obligation to restructure] so that unitholders are not penalised with [higher] fixed fees,” says Gan.

“So, the options are to close the fund, merge it with a fund with a similar nature and objective, change its mandate or up the marketing ante to grow its size. The last three options are rare as the processes are long and require the investors’ consent. It is more likely that the investors will be offered a switch to a similar fund, and the fund will be closed.”

Wong says the risk of liquidation is less of a concern for small equity funds than it is for small bond funds. The former funds’ holdings are more liquid than the latter’s. “Bond funds can be too small to diversify or hold a meaningful number of bonds. Fund managers may be limited to investing in [bond] odd lots and, in order to do that, [they may] settle for something more expensive. My advice is to avoid [bond] funds that are below RM10 million. With such funds, you have to be very careful since the management fees will consume a large part of the fund’s NAV.”




(Written by Tho Li Ming of www.theedgemalaysia.com)


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