As a number of behemoth funds dominate and cross-overs in buy lists appear to grow, investors are increasingly facing the dilemma of how to approach capacity.
Can they continue to justify backing mega-sized funds, but equally can smaller funds cater for large scale volumes?
Neil Woodford’s popular £12 billion High Income and £9 billion Income funds were recently placed on the ‘sell’ list in Sanlam’s Income study, due to their size and focus on very large stocks in the market.
The study said: ‘We would prefer managers who are able to be more pragmatic in the face of swiftly changing circumstances and therefore place sell recommendations here.’
While Woodford’s funds have been among the top performers over the long term and remain a favourite among wealth managers, size is still an issue for many investors.
‘We prefer Artemis Income – it’s smaller, but by no means small. We have some capacity concerns [with Woodford’s funds], but it’s not the only reason. He has a very dogmatic style in terms of sector allocations, although some might say that’s proved right.’
Capacity an issue
Fitzgerald adds that capacity is a bigger issue for funds investing in small companies, where a large amount of assets can hinder the ability to invest.
‘We sold out of the Standard Life UK Smaller Companies fund last year because it closed to new investment and went through the £1 billion mark,’ he said. ‘We thought there were more opportunities with smaller funds.’
However, Mick Gilligan, head of research at Killik & Co, does not think capacity is such an issue for managers who are longer-term investors buying large companies, and is still happy to back Woodford as a result.
‘Someone who invests in mega caps will obviously have a lot less of an issue,’ he said.
‘It also depends on their style and how active they are. If someone has a high turnover ratio, again it makes it more likely to be a hindrance. A mega cap, contrarian, long-term buy and hold investor like Woodford will have much less of an issue.’
Nonetheless, Gilligan is concerned about style drift. ‘There have been funds in the past that started off at the small end of the market but then they have grown in assets and moved up the market cap. We would flag this up as being an issue,’ he said.
However, there are also problems at the other end of the scale, with Nick Sketch, senior investment director at Investec Wealth & Investment, pointing to potential issues associated with smaller funds.
Small funds dilemma
‘We will be put under a lot of pressure because of dispersion of client returns. It may lead to the view that if you can’t own it for every single client, then you can’t own it for any. So really small funds might be the right way to go for performance, but who’s going to own them?’ Sketch said.
‘We think the situation is manageable at the moment, we can strike a sensible balance, and so we are treating people fairly. It’s a lot of work though.’
Aside from smaller companies, funds investing in Asia in particular can also experience capacity issues.
‘I’m most worried about the Asia funds that are getting too big,’ said Sketch. ‘I don’t want to buy the same eight stocks in an expensive wrapper, but that’s where the money has to go.’
He adds that this also causes some strategies to veer towards larger stocks. David Coombs, head of funds selection at Rathbones, also highlights the potential conflicts of interest between asset gathering and investment returns. Large funds attract higher fee income for the asset management company and therefore create more of a business risk to the firm.
‘In this situation there can be pressure on a manager to take less risk, which may impact alpha generation and lead to mediocre performance.’
Likewise, a large fund means more underlying investors and investor meetings and potentially less time spent by the manager running the fund.