Why small-sized mutual funds have remained unnoticed despite churning out good returns

Big surprises come in small packages. While large mutual funds struggle to keep pace with their benchmarks, a few, tiny schemes have churned out spectacular returns. A study by ET Wealth shows that 10 small-sized funds have given weighted average returns of 10.6% in the past year, compared with 1.9% delivered by the average diversified equity scheme. These money-spinners are not mid- and small-cap funds that invest in little-known stocks and typically have low asset bases. They are large-cap and multi-cap schemes, which invest in blue-chip stocks and are highly rated by Value Research.

Despite the good returns and high ratings, these schemes have not attracted the attention they deserve. In fact, instead of buying them, investors have moved out of these funds over the past three years. The total AUM of the 10 schemes has come down from Rs 787 crore in September 2010 to Rs 481 crore in September 2013, despite the 5 per cent absolute rise in the Nifty during this period.


Why are investors keeping away from these schemes? More importantly, why aren’t the financial planners and wealth advisers recommending these funds to their clients? Experts point to the low AUMs of these schemes. “Advisers typically recommend a fund if it has a big enough AUM. If the fund is too small, they avoid it,” says Vidya Bala, head of mutual fund research at Fundsindia.com.

Catch-22 situation

It’s a Catch-22 situation for the small funds. Advisers shun them because their AUM is low, but this amount won’t go up because they are not on the advisers’ radars. The total AUM of the 10 outperforming funds we studied is less than 5 per cent of the assets of HDFC Top 200. With assets of Rs 10,017 crore, HDFC Top 200 is the largest equity fund in India. Ironically, its 3-year annualised returns are negative, but it continues to be among the most recommended schemes by mutual fund advisers. This is true for most other big funds as well.

The combined assets of the 10 largest equity diversified schemes have risen by almost 22 per cent in the past three years, but their returns have been muted. With more than Rs 50,000 crore invested in them, these 10 big boys of the equity diversified category have given a weighted average return of 6 per cent in the past year and 1.1 per cent in the past three years. Many of them underperformed their own benchmarks and the broader market.

The other factor working against these schemes is that most of them are from smaller fund houses. “Investors like to run with the crowd and very few want schemes from lesser known fund houses,” says Bala. With returns of 15.36 per cent in the past year, Religare Invesco Equity Fund is among the best performing large- and mid-cap equity scheme, but its AUM is a measly Rs 18.9 crore.

Edelweiss Dividend Growth Equity Top 100 Fund has been assigned a 5-star rating by Value Research, but its AUM is only Rs 20 crore. In a few cases, extraordinary circumstances have contributed to the low AUMs.

After Fidelity Mutual Fund was taken over by L&T Mutual Fund, investors in the Fidelity India Value Fund have gradually moved out, causing the AUM to fall from Rs 199 crore in September 2010 to about Rs 43 crore now.

The infrastructure tag has hurt the Franklin Build India Fund. Despite its good returns, the poor prospects of the infrastructure sector have led investors to redeem their funds.

Big isn’t better

Some experts say that if a mutual fund becomes too big, its performance suffers. Given its size, it is not able to move as deftly as a mid-sized fund. Also, it is difficult to find the right investment opportunities, though this problem is more pronounced in the small- and mid-cap segments. “The mid-cap universe is limited and deployment can become an issue. Large-cap funds don’t face such problems,” says Bala.

Besides, small- and mid-cap stocks tend to be illiquid and if there is a sudden redemption pressure during a bear phase, the fund may have to sell the stocks at beaten down prices. If these small funds have performed well and are also highly rated, should you invest in them? “Investors should not shun these small funds altogether, but they should not be part of the core portfolio,” says Bala.