Size matters, but bigger isn’t always better when it comes to funds — as evidenced by a number of the 37 trophy winners of the 2011 Lipper Fund Awards.
Funds with an asset base under $500 million were among the top performers in the three-year trophy category, demonstrating the flexibility and agility that’s inherent to smaller funds. With a smaller portfolio, fund managers can pounce on market opportunities and trade in and out of securities with ease.
“Trying to move a multi-billion dollar product around actively would be much more difficult, given the size of the underlying market. I think our size is to our benefit,” says Roger Early, who co-manages the award-winning Delaware Inflation Protected Bond Fund with Paul Grillo at Delaware Management Company.
The Delaware Inflation Protected Bond Fund had $285.1 million under management as of Dec.31, 2010. Active since 2004, the fund primarily invests in inflation-indexed government debt and seeks to provide inflation protection and income for institutional investors.
“Delaware has a history of building our products on physical bonds — traditional, old-fashioned bonds. To do that in the Treasury Inflation-Protected Securities (TIPS) market, you’re at a significant advantage to be in the several-hundred-million size rather than trying to be several billion or multiples of that,” says Early.
The focus on tangible securities seems to be paying off – the fund’s three-year annualized total return was 5.82 percent as of Dec.31, 2010, outperforming the Barclays Capital U.S. TIPS Total Return Index, which had an annualized return of 4.97 percent for the same time period.
The same holds true for the mixed-asset class category. USAA’s First Start Growth Fund, which had $218.6 million under management as of Dec.31, 2010, counts its small size as one of the reasons it was able to capitalize on the boom in the bond market.
“One of the advantages is you can get in with a small amount of money compared to certain other funds. Another advantage is opportunities — look at (Pimco’s) Bill Gross, he’s managing $250 billion. He can’t buy a lot of the securities we can buy” and make a meaningful impact, says Arne Espe, vice president of fixed income research at USAA and one of the fund’s managers.
The fund courts long-term capital appreciation with stocks and seeks to reduce volatility with fixed income and money-market instruments. Its three-year annualized total return was three percent as of Dec.31, 2010, outperforming the Lipper Mixed-Asset Target Allocation Growth Funds Classification Average, which had an annualized loss of 0.61 percent for the same time period.
In addition to their nimble nature, investing early in one of these small stars could mean greater overall returns if a piece of the pie is purchased before the fund is flooded with assets. An early investment also means a reprieve from Uncle Sam, as taxable distributions are spread amongst subsequent investors. And small funds run by boutique firms are more accessible to advisers and clients, which means you might have a chance to bend the ear of managers.
“When they’re smaller like that and you’re looking at being a potential large fish in their fish tank, they may be willing to do some special deals for you,” says Diane Pearson, financial adviser with Legend Financial Advisors.
However, Pearson cautions investors against throwing all their eggs in one small basket, stressing it’s imperative you do your due diligence. While some funds may purposefully maintain a smaller asset base to maintain nimbleness in the market, others may be struggling after substantial outflows.
“If they have had a major exodus, you need to ask was it because of market activity, was it because of their performance or was it potentially that they had a shareholder that was large in size and when they pulled out, their assets went with it? You have to understand why they have a lower dollar amount,” says Pearson.
Size can also have an adverse affect on costs as it’s more difficult for smaller funds to achieve economies of scale, meaning higher administrative costs as a percentage of assets under management. “You will typically see expense ratios of two percent or more for funds with asset bases sub $100 million. That’s pretty much the standard,” says Stephen Roge, a portfolio manger with RW Roge & Company.
New issues – especially boutique offerings – also pose substantial continuity risk, as managers try to establish a fund’s legs. However, a small fund from an established firm may be just the ticket.
“We don’t roll out lots of funds, we don’t merge funds if there is a performance hiccup, and we don’t shut down a lot of funds. I would say we acknowledge the issues with smaller funds, but in our institution, when we commit to a fund, we think it makes sense to our members,” says John Toohey, vice president of equity investment at USAA and one of the fund manager with USAA First Start Growth Fund.
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