I recently read a book entitled ‘David and Goliath: Underdogs, Misfits, and the Art of Battling Giants’ written by author Malcolm Gladwell. The book aims to break down situations where being an underdog is, at least on the face of it, a disadvantage. When you scratch the surface however, a multitude of small factors can actually be seen as advantages and enable positive outcomes. This made me think of the extent to which the famous fable of David and Goliath applies within the investment world.
The size of a fund plays a fairly large part in both a prospective and existing investor’s mind when evaluating it, and there is certain validity in the reason as to why size is such a big consideration.
A relatively large fund can give an investor comfort in multiple ways; be it good liquidity for the investor, small ownership of the fund as a percentage of the total assets or even simply, great performance resulting in a decent following.
Large investment firms tend to naturally have large funds. They have a surfeit of resource, which means that the research carried out is both extensive and broad - often meaning that outperformance can, in theory, be achieved through being able to find better investment opportunities than those without so much resource. They have manpower on their side, enabling them to roll out many different funds that focus on investing in different sectors, regions and asset classes. They also tend to have offices all over the globe giving them access to a large pool of investors. So why wouldn’t an investor go with a large, seemingly popular fund?
Once a fund gains scale and is well-ranked within their respective sector, this is where difficulties can arise. Most funds have theoretical capacity limits that mean their investment process (and the reason they reached this size in the first place) can become compromised once the fund reaches a certain size. Once a fund becomes ‘too’ big it is particularly common for those that invest in smaller markets, for example in Asian equities, to close to new investors to prevent the problem of becoming ‘too’ big. An example would be a fund of 30 stocks that receives another £1bn of investors’ money. The fund manager will prorate the new money across the existing holdings in the fund, but this may now mean that the fund holds a material position in an underlying company. This might give rise to unwanted corporate governance and it could also create an illiquid position.
Closing a fund to new investors can be a conflicting choice for fund managers as their fee is usually directly correlated to the total assets under management. Crudely, declining new money is essentially rejecting a larger management fee. It is therefore very important to make sure that a fund manager’s main objective is to run the fund without compromise to the investment process and that their interests are firmly aligned with those of the investors. This is a lesser issue for smaller funds and fund houses, which can simply concentrate on finding the best investment opportunities for their investors without sacrifice.
One could argue that smaller funds have advantages over their larger counterparts which could actually mean they’re a favourable choice. As an investor in a smaller fund, the chance of direct access to the fund manager is increased and this could be invaluable as questions you might have could be answered by the very person who is radically responsible for the way your money is invested.
It’s not uncommon for smaller funds to have lower annual management charges than large, globally established funds, in order to attract investors. While a slightly smaller fee doesn’t look like it would have much of an effect on the end value of an investment, once the difference is compounded over a long time frame, the effect will be more discernible.
In conclusion, while there is perceived comfort in investing in large and well-known funds, often with merit, it’s important not to let the factor of size sway an investment decision. In a world where there are an overwhelming number of funds on offer, it could prove detrimental to an investor’s return to neglect the less-publicised, smaller funds whose positive attributes may outweigh their behemoth counterparts’. It’s worth attempting to find these ‘Davids’ in a world where the ‘Goliaths’ tend to steal the show.
Article taken from Contact Magazine March/April Edition