Mutual Fund Strategy: A large asset under management (AUM) and an impressive recent return may make a mutual fund appear attractive, but investors should not use either metric as the sole basis for choosing a scheme, mutual fund experts told Zee Business.
The debate is particularly relevant for investors who tend to gravitate towards popular funds with massive AUMs or chase schemes that have topped return charts over the past year.
According to mutual fund experts Hrishikesh Palve, Director at Anand Rathi Wealth, and Vikas Puri, Senior Partner at Complete Circle Capital, fund size does matter—but there is no direct correlation between a large AUM and better future performance.
“A myth” is how Palve described the belief that a larger fund will automatically generate better returns.
“We have analysed several categories of funds and found that this does not hold true. There is no strong correlation that if the fund size is very large, its performance will also be exceptionally good,” Palve said.
While a large AUM can create certain investment limitations, investors should not reject a fund simply because it has become too popular, the experts said. Instead, they should look beyond AUM and recent returns and evaluate several other factors before investing.
1) Start with your investment goal, not the fund’s popularity
Before looking at a fund’s AUM or returns, investors should first determine what they want to achieve through their investment.
Palve said fund selection should begin with clearly defining an investment objective.
“The first thing is to determine your goal. When you invest in equity mutual funds, you need to be clear about what you are trying to achieve,” he said.
He added that investors should avoid selecting a scheme merely because it has performed well in the recent past.
“You cannot drive a car by looking only in the rear-view mirror. Similarly, you cannot select a fund only by looking at its past performance,” Palve said.
The investment objective should therefore come before a fund’s popularity, size or recent ranking.
2) Check how the fund fits into your overall portfolio
Investors should not look at a mutual fund in isolation. Instead, they should examine how it fits into their broader portfolio.
Palve said equity mutual fund investors need to consider their exposure across different market capitalisation segments, including large-cap, mid-cap and small-cap stocks.
“The market capitalisation mix is important. You need to see how much exposure you have to large caps, mid caps and small caps,” he said.
For equity mutual fund investing, Palve also stressed the importance of building a basket of funds rather than depending entirely on a single scheme.
“When you invest in equity mutual funds, you should not necessarily depend on just one fund. You need to build a basket of funds because different funds can complement each other over a period of time,” Palve said.
The key is to ensure that the funds selected complement one another and fit the investor’s broader investment strategy.
3) Understand the fund manager’s investment style and the AMC’s track record
A fund’s recent returns can fluctuate depending on market conditions. Investors should therefore also understand the investment approach behind those returns.
Palve said that after deciding the categories in which they want to invest, investors should examine the fund manager’s investment style and the track record of the asset management company (AMC).
“Once your categories are confirmed, it is very important to understand the fund manager’s style and also look at the AMC’s track record,” he said.
He added that several other factors should be considered while selecting a fund rather than focusing only on its size or one-year performance.
Understanding how a fund is managed can help investors assess whether its approach fits into their overall investment strategy.
4) Look at consistency over at least 3-5 years, not just one-year returns
One-year returns can be tempting, particularly when a fund delivers spectacular gains and quickly becomes an investor favourite. But Puri warned that relying heavily on a single year’s performance can increase the chances of making a mistake.
“One year is a very short period. If you select a fund only after looking at one year’s performance, the chances of making a mistake can be higher,” Puri said.
He suggested that investors look at performance over at least three to five years and focus on consistency.
“If you have two funds and one has delivered 32-33 per cent in one year but has a much lower five-year CAGR, while another fund has delivered a relatively lower one-year return but a stronger five-year CAGR, the second fund may demonstrate better consistency,” Puri explained.
Palve also said investors should look at performance over periods longer than one year because mutual funds can go through phases of volatility and mean reversion.
Rather than chasing the latest top-performing scheme, investors should examine how consistently a fund has performed over different periods.
Puri said a fund does not necessarily have to remain No. 1 every year to be a strong investment option.
“The important thing is not whether a fund remains number one every year. What matters is how consistently it remains among the better-performing funds,” Puri said.
A fund that consistently remains among the top group may be preferable to one that ranks first in one year but falls sharply in subsequent years, he added.
5) Check AUM—but understand what a large fund can and cannot do
AUM should not be ignored completely. However, experts said it should be treated as one parameter among many rather than a reason by itself to invest in or avoid a scheme.
Palve said a very large fund can face challenges related to flexibility.
“When the fund size becomes very large, flexibility can get affected. If the fund wants to invest in a smaller company and there is limited trading volume, getting the desired entry point can become difficult,” he said.
The fund manager may have to spread purchases over time, and the stock price may move away from the preferred entry level.
Puri explained that as a fund becomes very large, its investment universe can become narrower.
If a fund managing around Rs 1 lakh crore wants to take a meaningful position in a relatively small company, deploying even a small percentage of its portfolio could involve a very large amount of money.
“As the AUM becomes very large, the investment universe can start becoming narrower. A fund manager may find it difficult to take meaningful positions in smaller companies without creating a significant market impact,” Puri said.
Smaller funds, in comparison, may have greater flexibility to invest in emerging or relatively less-explored companies. However, that does not mean every smaller fund will outperform.
“It would be wrong to say that a large fund will necessarily underperform or that a small fund is guaranteed to perform better,” Puri said.
Palve similarly said that investors should not decide whether to invest in a scheme solely on the basis of its AUM.
“The size of the fund is only one factor. It cannot be the sole reason to select or reject a fund,” he said.
He added that investors should also consider governance and other scheme- and AMC-level factors.
Don’t chase the No 1 fund
According to Puri, consistency is more important than a fund’s ranking in a particular year.
A scheme does not have to remain at the top of the rankings continuously to be a potentially strong long-term option.
A fund that consistently stays within the top group of performers may be more reliable than one that becomes No. 1 for a short period and then slips significantly in subsequent years.
The focus, Puri said, should be on how consistently a fund performs rather than how often it occupies the top spot.
Key takeaway for mutual fund investors
For mutual fund investors, a large AUM should neither be an automatic buy signal nor a red flag.
Similarly, a strong one-year return should not be mistaken for proof of long-term investment quality.
Before selecting a mutual fund, investors should first consider their investment goal and then examine how the scheme fits into their overall portfolio. They should also look at the market-cap mix of their investments, the fund manager’s style, the AMC’s track record, and the fund’s consistency over longer periods.
AUM remains an important parameter, but experts say it should be considered alongside other factors rather than treated as the deciding factor.
Ultimately, for investors considering a popular mutual fund, the more important questions may be: Does the scheme match my investment goal? Does it fit into my overall portfolio? Does the fund manager’s approach suit my investment strategy? And has the fund shown consistency over a longer period?
The experts’ message is clear: investment goals and portfolio strategy should come first, with AUM and past returns serving as factors to evaluate—not the sole basis for selecting a mutual fund.