When we talk about investment in mutual funds some of the main factors to be considered are the past performance of the fund, risk factor, fund manager’s experience, and expertise, investment budget, cost-benefit analysis, etc. The size of the fund is often not looked at as an important consideration while making an investment decision by the average investor. Fund size may not be the sole contributing factor that may sway the decision of the investor, it is definitely not to be ignored.
Given below are the meaning of the term AUM and its relevance in different categories of mutual funds.
What is the meaning of AUM?
AUM is the abbreviation used for Assets Under Management. It is the total market value of investments that are held by the fund. It is also commonly referred to as the fund size or asset size that is managed by the fund manager. It is the pool of funds invested by all categories of investors (individuals, corporates, or any other entity or organizations). The fund size or the AUM of the fund is not constant and changes on a daily basis.
Impact of AUM on each category of funds
AUM can be a good yardstick to measure a fund’s performance against its peers as well as get an idea of the returns that can be earned by the fund. Many investors assume that if a mutual fund is larger in size, it must be good and provide higher returns to the investors. This is not always true as the true impact of AUM cannot be standardized and is dependent on the type of mutual fund. The details of such an impact of AUM on various classes of funds are discussed below.
The importance of AUM in the case of equity funds is not as pronounced. The main factors that are considered for investment in equity funds are the fund performance, the fund manager’s expertise, and the risk parameter of the fund. The AUM of the fund in the case of equity funds is not given higher importance as there may be many equity funds that have a smaller AUM but can generate higher returns. There may also be a case where the fund is hugely popular but may not provide huge returns to the investors.
The impact of AUM on debt funds is more apparent or pronounced in the case of debt funds. Debt funds are the funds that invest predominantly in debt instruments like corporate or government bonds, commercial papers, T-Bills, money market instruments, etc.
A larger fund size in the case of debt funds will help the investor in getting the benefit of a reduced expense ratio and ultimately higher returns. However, there may be a case where the fund is not able to meet the liquidity requirements of the investors on account of the huge fund size. Hence, it can be said that the performance of the debt fund is reliant on the AUM of the fund or the fund size.
Small cap and mid cap funds
Like debt funds, small-cap and mid-cap funds are also affected by the AUM of the fund. Many small cap and mid cap funds have the policy to restrict investment or cash inflow beyond a certain point of fund size or any other restrictions as per their guidelines. This is mainly on account of various regulations laid down by SEBI with respect to the investor holdings and trading norms. Mid-cap funds are also impacted by the size of the fund. A growing mid cap fund can potentially provide higher returns to its investors as there is a higher volume of investments and more returns generating avenues.
Large cap funds
Large-cap funds are that category of equity funds where the returns are not hugely impacted on the basis of the fund size. There are few examples of large-cap funds having a lower AUM but generating higher returns. Hence, in the case of large-cap funds, it is advisable to look out for other parameters mentioned above like risk-return ratio, past performance, fund manager details, expense ratio, etc. to make an investment decision regarding the large cap funds.
Impact of AUM on expense ratio
The expense ratio is the cost of managing the investor’s portfolio that is levied by the fund house. This expense ratio is the annual cost to manage the fund and is expressed as a percentage of the fund size. The expense ratio of the fund is in relation to the operational costs involved in managing the fund and does not affect the fund performance. As per the SEBI guidelines, the fund house has to ensure that the AUM is always higher than the expense ratio.
AUM may not have an impact on all categories of funds, it is nevertheless not to be ignored. Another important point for the investors to remember is that an excessive fund size may also have an adverse effect on the liquidity of the fund as well as its performance. However, it is the fund manager (especially in the case of equity funds) that is the driving force for the fund performance.
1. Is the AUM of any fund constant?
A. No. The AUM of a fund changes daily based on the value of the underlying assets of the fund at the end of the trading day.
2. Does the performance of the mutual fund impact its AUM?
A Yes. A mutual fund that has consistently performed better will be able to add more assets to its fund on account of increased returns. On the other hand, a mutual fund that has not performed better will see its assets being drained thereby reducing its AUM.
3. Does having higher AUM have a negative impact on the fund performance?
A. There is no proven data or statistics which show that having higher AUM will have a negative impact on the fund performance. The performance of the fund is based on many factors like fund manager abilities, experience, assets of the fund, etc. However, there could be cases of the fund manager not being able to allocate the excessive funds to the best possible extent or not being able to liquidate the fund faster on account of higher exposure to a particular asset.
4. How can the assets of the fund be increased?
A. The assets of the fund can be increased by way of increased returns from existing investments which can be re-invested in the fund or by increased investments by new or existing investors as a result of better performance of the fund.
5. Is a fund with a lower AUM a bad investment opportunity?
A. AUM represents the size of any mutual fund. A lower AUM indicates a lower investor pool but that does not necessarily translate to a bad investment opportunity. The fund size may be small but the returns generated and the brisk factor may be in favor of the investors. Hence, AUM cannot be solely considered for making an investment decision.