Just like in life, bigger is not always best. A great example of this can be found in sport. Elite athletes come in all different shapes and sizes depending on their area of specialty, but all share a common trait of training purposefully to win.
We can think of managed fund selection and whether size is an important factor in a positive or negative sense in a similar way.
To run or sprint?
Whether you are running or sprinting, you are doing the same physical motion. One foot in front of the other, and moving toward a finish line. However at an elite level, both activities require very different characteristics in order to succeed.
In sprinting, winning comes down to hundredths of a second. Technique, along with power produced from the leg’s calf and thigh regions and a higher proportion of “fast twitch” muscle fibres propel athletes at speed to the finish line. Think of Usain Bolt; the world’s current 100 meter and 200 metre record holder. His tall 1.95 metre frame houses long muscular legs that give him the slightest advantage over his opposition. But it is those hundredths of a second that add up and help him achieve world record success. Having said this Bolt is more of an anomaly in the 100m space, with his build being better suited to 400m, and the 100m distance being dominated by “wider” athletes.
On the other hand, the diminutive Kenyan long-distance runner Eliud Kipchoge is considered the world’s best marathon runner. While a similar age to Bolt, his 1.67meter frame is 14% shorter and 45% lighter than Bolt’s. Yet the physiological differences don’t end there. With a sprint as a brief explosion of energy, the marathon is a high intensity, endurance event. Kipchoge would operate an above average cardiovascular system in order to run the gruelling 42.195 km race in under 2 hours.
Just as these athletes have different physical requirements to run their specialised event – fund managers have differing characteristics too.
Size vs the Universe
Irrespective of whether you are investing in a bond, equity, or alternative investment fund; it’s important to consider the universe of what they say they can invest in and compare that to a fund’s current size, and whether there are any limits on that size (e.g. a closed-end fund).
The investible universe for a fund can be limited by some or all of these attributes;
- Asset class (e.g. cash, bonds, equities etc)
- Geography (e.g. Australia, New Zealand, global etc)
- Size of issue (e.g. minimum issue size of bonds, market capitalisation of shares)
- Liquidity
- Or other factors like credit ratings, issuer types etc.
The best way to see how this can work, is to look at some specific examples.
When do I want small?
Being small is an advantage if an investment manager is managing microcap equities and only invests in Australian listed companies typically with a market cap of less than A$500m and outside the ASX 100. While the fund may perform well if it has selected some winning companies, its past performance may not be able to be replicated if its funds under management growth rises too quickly. That’s why some funds may actually say that they will limit the amount of any new investments from investors (hard closing the fund). This is because the fund manager may be limitd by maximum holdings in their preferred companies (typically 10%) and will need to find other names to invest the assets in. Once a manager owns a significant shareholding, making an exit can be difficult at the right price. This space is often suited to a closed-end funds.
<<Search here, by entering “Micro” in the Power Search>>
There is an unwritten rule of thumb that an equity manager can comfortably run 1% of free float market cap, but there are lots of variables and different opinions. In the global equity space, size constraints are less of an issue, given the size of companies and the universe. So this is where having the appropriate resources is the key factor to consider.
There are many advantages when managing a small pool of assets in the early phase of growth. It is therefore important to consider if the manager is running the strategy as they would at scale, in particular they are owning position sizes in companies that will be possible when running 20x the FUM and can performance be maintained.
When do I want large?
If an investment manager runs a bond fund, it’s usually helpful to have a large asset base under management. This is because bonds tend to have a minimum parcel size of $500,000, and the more funds under management, the more likely you will be shown new issues from companies, banks, sovereigns, governments, or other product issuers. Bond markets are very deep, with billions outstanding. On average, the market of investment bonds has been 79% larger than the stock market over the last 25 years.
Unlike equities there are many different ways to invest in a bond, for example, there are over 1000 different ways you can invest into CBA debt, fixed, floating, onshore, offshore, term, as well as position in the capital structure. Therefore to be properly diversified, it is important to have sufficient scale.
Bond funds should typically be larger than $500m in order to be considered sizeable – yet these levels are still considered on the small side for institutional investors, Kiwisaver, Superannuation, or other pension funds.
<<Do some research into bond funds here>>
Broadening the Fixed Income universe to credit we would argue there is a balance where scale helps to diversify and get access to certain issues, but being too big limits position sizes as in the equity space.
What about the team?
Even in individual elite sports, athletes have a team around them, but too many opinions can be detrimental. In investment management, there are benefits of both. Small teams tend to be fully invested and can be more aligned. However, don’t discount the benefits of larger fund managers. Think operations, sales, compliance, trading, reporting, HR, as well as delivering the mail. In addition, scale brings with it other efficiencies, not only better systems and people, but also access to company management, often small shops simply don’t get the access to company management, they have to go to the highly inefficient (time and information) public briefings. We will explore this further later in the series.
Size does matter, but it depends on your chosen sport and particular race as to what attributes are required.
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