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Should you look at AUM before investing?

9 Mins 25 Jul 2023 0 COMMENT

The asset under management (AUM) of a mutual fund scheme is the total market value of all the assets – stocks, bonds, cash, and other securities that are part of the portfolio – that a mutual fund manages on behalf of its investors.

A mutual fund is an investment tool that pools money from a large number of investors and uses that money to purchase securities on their behalf. The value of the securities held by the mutual fund fluctuates with market conditions, which means the total AUM of the mutual fund can also go up or down accordingly. AUM can also increase or decrease when investors invest more or start withdrawing their money.

AUM can be an important gauge to understand how the market perceives a particular fund. For instance, if the AUM of a fund is significantly larger than its peers in the same category, it can signify that investors are preferring that fund over its competitors. The reason for this behaviour can be different such as better performance compared to peers, and the reputation of the fund manager managing the fund, among others.

The AUM of a fund can also be an indicator of the fees that the fund charges, as many funds charge a percentage of assets that they hold as their management fee. For this reason, according to the Securities and Exchange Board of India (SEBI) rules, larger funds tend to have relatively lower expense ratios.  

Many investors use AUM as a factor in their decision-making process when selecting a mutual fund to invest in. There is some logic behind this behaviour. What AUM can tell you about a mutual fund scheme depends on several things, but the most important is where the fund invests.

Large cap fund

If the fund is a large cap fund, that is, it invests in some of the largest companies listed in Indian stock markets, then having a large AUM is neither an advantage nor an impediment. Since such stocks tend to be highly liquid, mutual fund managers can easily purchase hundreds of crores worth of stocks without a hitch.

Small cap fund

The AUM of a fund matters if it focuses on small cap space. Let us understand with an example. Suppose there is a small fund with an AUM of, say, Rs 500 crore.  If it wants to allocate 5% of its AUM (Rs 2.5 crore) to a smallcap company with a market capitalisation of Rs 1,500 crore, the fund manager will not face much difficulty in purchasing Rs 2.5 crore worth of stocks from the market.

Now, assume that the AUM of a fund is Rs 10,000 crore and it wants to allocate 5% (Rs 500 crore) of the AUM towards the same company. Rs 500 crore is a third of the value of that company and the fund manager will find it extremely difficult to acquire such a large stake.

What if the fund manager allocates just 1% of the AUM, which is Rs 100 crore? It has two implications. One, yes, it is possible for the fund to acquire Rs 100 crore worth of shares of Rs 1,500 crore company from the open market, but the impact cost will be much higher. Impact cost refers to a sharp movement in share price due to the trading activity of a fund. That is, when the market notices that a fund house is trying to buy whatever stock is available in the market, the stock price will move higher.

The second implication is that such a small allocation will not have much impact on the fund’s performance, especially if the fund manages a concentrated portfolio. Many fund managers, for this reason, try to avoid investing small chunks in any stock as the resultant impact due to their price movement is minuscule.

Impact on performance

Many believe that funds with relatively smaller AUM tend to perform better as they are much more agile, that is, they can take bold decisions and move into and out of a stock much more efficiently. On the other hand, larger funds tend to be relatively inflexible as they cannot move into or out of a stock with the same ease without suffering any impact cost.

So, when does a fund gets too big? There is no concrete answer to this question. For largecap funds, having an AUM of Rs 10,000 crore is not a big issue. But for a small cap fund, this is a large AUM and it may face challenges as it grows bigger.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. AMFI Regn. No.: ARN-0845. We are distributors for Mutual funds. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.