Like in stock market people say that when the share price is high don’t buy. I would say that when it comes to mutual funds don’t buy mutual funds when AUM (Assets Under Management) is high.
Basics of AUM and NAV
What is AUM?
AUM stands for Asset Under Management. The total fund a mutual fund scheme holds for investments.
What is NAV?
Net Asset Value. It is the value per share of a mutual fund or an exchange-traded fund (ETF) on a specific date or time.
What is Alpha?
Alpha is the extra returns generated by the mutual fund over and above its benchmark (Nifty, etc).
Hypothesis: Mutual funds with high AUM don’t perform
So, the hypothesis is pretty simple. If the AUM of the mutual fund becomes significantly high, the performance of the mutual fund takes a hit. The reason is that it is difficult for a fund manager to find enough high return opportunities that can generate significant Alpha (Fund -Benchmark).
I tried to prove this hypothesis by looking at the performance of 7 mutual funds (AUM 10K+ in equity category). These mutual funds are broadly from three sub-categories: Tax, Large Cap and Multi-Cap.
I will basically plot the AUM and Alpha on a quarterly basis to conclude this.
Tax Category Analysis
Axis Long Term Equity is the only tax mutual fund that has AUM > Rs. 10k Cr and its AUM growth is crazy.
Since the last 1.5 years, when this fund crossed ~Rs. 6k, it has not generated any alpha. Today, if you look at any performance metric like returns 5Y, returns 3Y, Sharpe Ratio, etc, all look very good. However, that is only due to its performance from when the AUM was lower.
Multi Cap Category Analysis
There are two funds with an AUM that crossed Rs. 10k Cr: ICICI Value Discovery Fund and HDFC Equity Fund.
ICICI Value Discovery
Its performance also deteriorated significantly over the last 1.5 years when this fund crossed ~Rs. 10k. It has not generated any significant alpha since.
One reason why still lot people suggest ICICI Pru Value Discovery Fund for investment is that they look at historical returns and these returns look really good.
In last year, a rate of 27.7% looks so good but it is lower by ~2% from the benchmark.
The 3Y and 5Y numbers look too good to not recommend. There one basic error in this: period bias. The mutual fund performed so well from 2011 to 2015 that all numbers now look good.
Category: Mid Cap
There is only one fund with an AUM of Rs. 10,000+ Cr: HDFC Mid-Cap Opportunities Fund. You might have heard a lot of Small Cap and Mid Cap funds stop taking new investments despite their AUM being below Rs. 5,000. Hence, I thought that I will not find any fund in this category, but I did.
From the chart, it looks like the fund has started performing poorly after crossing Rs. 8k in AUM. I would like to praise the fund manager for managing such a huge AUM in this category. At the same time, I think its getting difficult after Rs. 8k in AUM.
Conclusion for Mid Cap Category
In the Mid Cap category, a mutual fund rarely generates alpha when its AUM crosses Rs. 8,000 Cr. Hence, some mutual funds, like Mirae Emerging Bluechip Fund did, stop taking new lump-sum investments and put a limit on the SIP amount.
Large Cap Category Analysis
In this category, I think a high AUM of even up to Rs. 15k should be good. There are three mutual funds with an AUM of Rs. 10k+ Cr: Birla Frontline Equity Fund, HDFC Top 200 Fund and ICICI Prudential Focused Bluechip Fund.
Chart on Alpha v/s AUM for HDFC Top 200 Fund
This fund crossed Rs. 10k Cr just before Mar-14. But the impact of performance drop is much higher after Rs. 12k Cr.
Conclusion for Large Cap Category
Overall, in this category, the performance drop due to high AUM is not significant on alpha as large cap mutual funds have lot of depth. 80% of investments in the Indian stock market is in large cap. B the t interesting thing to note is that the overall alpha in this category is low. The only exception is Mirae Asset India Opportunities Fund.
I think with the above data, we can conclude with reasonable certainty, that the performance of a mutual fund goes down significantly after it crosses a particular AUM. That AUM limit is different for different categories.
So, always look at the AUM of the mutual fund before investing.