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What are Mutual Funds?

To understand the concept of mutual funds, let us take the example of a company that gathers some people and takes their money to invest in this portfolio. Therefore, mutual funds are a managed portfolio of stocks or even bonds. What actually happens here is that a sharer of the mutual funds is divided among the investors which are portion of their holdings.

Relation of Size with Mutual Funds:

So, does size really matter in a mutual fund? Does the change in size affects the mutual funds? With size, we mean the total amount of money that has to be overseen by the mutual fund manager before investing.

The point at which the size begins to affect the mutual funds is when positive effects of the total return performance of the fund are canceled by the negative effects of the size of the mutual fund. To better understand this, it is the point at which the efficiency management’s relationship with the size of the funds becomes negative.

You must be eager to know as to when is this point reached? Well, there is no fixed time at which this point might occur but at the time when the mutual fund manager fails to produce the fund’s return according to the historical record as the manager is unable to maintain the investment strategy of the fund.

In mutual funds, the size of the fund is related to the investment style. Typically, when the investment style is overgrown by the funds, the mutual fund suffers.

Apart from this, there is another problem which occurs in case of the mutual fund being too large. It becomes very difficult for the mutual fund manager to actively manage the large funds. Too large mutual funds are known as closet index funds. The portfolios become similar to that of the index funds. In the case when funds become too large, the fund manager must divide the funds’ assets in different stocks because investing all the funds in a single stock will affect the share price.

These are the problems associated with the mutual funds being too large. But does that mean that a smaller mutual fund is beneficial?

In many cases, the mutual fund managers prefer smaller sizes of funds. Why? Maybe because handling smaller mutual funds is easier and not that complicated. Another reason is that smaller funds provide exceptional short-term performance.

Smaller funds can also be a bit misleading. As discussed, smaller mutual funds show excellent short-term performance because a few successful stocks in the portfolio could have a large impact on the fund’s performance. These funds are not that diversified so a poor performance in a stock will have a huge impact on the overall performance of the funds.

In case of operating expenses, the smaller funds are more expensive to manage as compared to larger funds.

At the point mentioned above, size does have an impact on the mutual funds’ performance, managing and operating costs.