Mutual funds are popular vehicles for getting diversified investment exposure to entire asset classes as well as to professional money managers.
However, one potentially overlooked risk of investing in mutual funds is known as “asset bloat.”
Investors have a well-known habit of chasing performance and fund managers who have a hot hand. Therefore, funds with attractive recent performance tend to attract more investor dollars.
Yet, size can make it tougher to duplicate those eye-catching past returns. There are several reasons why an influx of assets can make things tougher for a fund manager. First, he or she might have a harder time staying nimble as their speedboat-sized fund grows into an oil tanker.
Also, inflows coming to the fund may force the manager to put that money to work in the market if they don’t want to sit in cash. This means the manager may no longer have the luxury to invest in only their best ideas.
Finally, large funds may impact the prices of stocks they’re buying and selling, especially if the securities are less liquid, such as micro-cap stocks, for instance.
“With a remarkable equity rally behind us, asset bloat is a concern to keep in mind,” says Russel Kinnel, director of mutual fund research at Morningstar. “Although U.S. stock fund flows have been fairly modest overall, some funds have been awash in new money.”
He notes that some funds are able to thrive and outperform even as assets grow, which may be due to the skill of the manager.
“Bloat is worth considering when you make investments, but don’t let it drive the decision you make on a mutual fund” Kinnel wrote. “Expense ratios, the record under the current manager, manager investment, and stewardship of the parent company are all more important determinants of a fund’s success. Having too much money to run can be a detriment to performance but how much varies significantly.”
In hedge funds, there is also evidence that smaller and younger funds tend to outperform their older and larger peers, on average.
DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Past performance is no guarantee of future results.