Can the jumbos dance?

We ran a series last week where we discussed the implications of rapidly growing size of funds. We tried to find out if size adversely impacts performance. In this series, we discuss the implications of steering a jumbo-sized fund and the challenges it poses for the fund manager, which, over time, may reflect in its performance numbers.

Limited universe

The assets managed by Indian mutual funds have shot up in the last five years, right alongside stock prices. This has ensured that equity assets, as a proportion of the listed market cap, haven't risen at an alarming pace. But the problem faced by most fund managers is that while the market cap has zoomed, the universe of investment-worthy stocks hasn't expanded much. This has led to more and more inflows chasing a stagnant pool of investible stocks.

Running a simple screener on 1,100 regularly traded stocks on the NSE, for instance, one finds that there are 38 stocks with a market cap of Rs 25,000 crore or more in September 2012. By September 2017, with many mid caps graduating to large caps, that number more than doubled to 82. But the total assets of large-cap equity funds more than trebled in these five years, from about Rs 55,000 crore to Rs 1,79,000 crore.

Even if you adopt a more liberal definition of 'large cap' and lower the market-cap requirement to Rs 10,000 crore, only 153 stocks make up this entire universe today. And do remember that it is not just specifically designated large-cap funds but also multi-cap funds, ELSS funds, balanced funds and mid-cap funds which look to park a portion of their portfolio in large caps.

The mid-cap universe has seen even less expansion in the investible universe. If you consider a market-cap range between Rs 2,500 crore and Rs 10,000 crore for a stock to qualify as 'mid-cap', the number of such stocks on the NSE has gone up from 138 to 177 in the last five years. But the assets of mid-cap funds have galloped more than threefold from Rs 29,200 crore to Rs 1.01 lakh crore.

The number of stocks in the small-cap universe may appear optically large because of the large number of listed stocks in the Indian market. But stocks below Rs 2,500 crore in market cap have actually shrunk from 785 to 674 in the last five years, even as small-cap funds have seen their assets bloat tenfold, from Rs 2,250 crore to Rs 24,400 crore. The small-cap universe has shrunk because the superior quality stocks here have graduated very quickly to mid or large caps.

The recent pickup in the IPO market is helping to expand this investment universe. But given that IPOs only raised Rs 30,000 to Rs 40,000 crore in new money in recent years against the listed universe of Rs 131 lakh crore, they don't make a very big difference to the supply. Many of the recent IPOs have also tended to list as large caps to start with, and haven't really added to the small-cap or mid-cap shopping list.

The problem of too much money chasing too few stocks is, therefore, more acute for mid-cap and small-cap funds than for large-cap funds. It wouldn't have been a problem if these funds hadn't seen incremental inflows as they could have simply stayed put with their existing stock picks. But then, given that the top performers in the mid-cap and small-cap categories have received a flood of inflows, they have been forced to scour an increasingly expensive market for scarce opportunities.

This is exactly why many funds in the small-cap and mid-cap space like, Mirae Asset Emerging Bluechip, DSP BlackRock Microcap, SBI Small and Midcap have shut their gates to either lump-sum investments, SIPs or both many months ago in this bull run.

But if burgeoning fund size has been a problem for mid-cap and small-cap funds, managing size is no cakewalk for large-cap funds either. As Vetri Subramanian, Group President and Head of Equity at UTI Mutual Fund, explains "As your fund size increases, the law of large numbers starts to kick in. Your investment universe shrinks and the liquidity of the underlying positions can be a challenge. As large funds are forced to invest mainly in the top market-cap companies due to liquidity considerations, the ability to create alpha will reduce."

Following are the links to the second and third part:
Mandate matters
Liquidity challenge