This article delves into the advantages and challenges associated with fund sizes across various types and its real-world implications on your mutual fund investments.

This article is a Guest Post from one of Arthgyaan’s earliest readers who is a fellow personal finance enthusiast.

About the author: Muthu Kannan, also known as Manki, is a software engineer by profession. He is intrigued by all sorts of things in life. One of them happens to be personal finance and investing.

In the personal finance space, his passions include teaching others (which is just a fancy name for learning by answering other people’s questions), building tools (mostly spreadsheets as of now), and writing about his revelations occasionally.

Readers of Arthgyaan may be interested in his blog posts about personal finance. Links to his other work and social media handles are on his home page manki.in.

Now over to Muthu Kannan (aka Manki).

📚 Table of Contents

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• tl;dr summary
• How AUM affects actively managed equity funds
  • AUM’s impact on small and micro cap exposure
• How AUM affects passively managed equity funds
• How AUM affects bond funds
• How AUM affects arbitrage funds
• How AUM can affect longevity of funds

What is AUM of Mutual Funds?

AUM, short for Assets Under Management, is the value of all the assets and liabilities of a mutual fund combined. If a mutual fund holds equity shares worth ₹100 crore, bonds worth ₹95 crore, and ₹5 crore as cash, the fund's AUM is ₹100 \+ ₹95 \+ ₹5 \= ₹200 crore. As you'd expect, the AUM changes every day, but it is published less frequently (at least once every 14 days for debt mutual funds and at least once a month for other mutual funds).

tl;dr summary

Here is a quick summary of the article if you don’t want to read it all:

• Being small (low AUM) offers some advantages to actively managed equity funds.
• Being large (high AUM) offers some advantages to passively managed equity funds.
• Size of the fund is irrelevant for bond and arbitrage funds.
• Small funds have a higher risk of getting shut down by AMCs.
• Everything in this article is theoretical. It is not hard to find funds that defy the theories put forth by this article, so don’t read too much into AUM numbers.

How AUM affects actively managed equity funds

Every actively managed fund plays a zero-sum game with other active investors in the market. Any additional return that the fund earns over the market return must come through other active investors’ underperformance in relation to the market. (This article discusses how active investing is a zero-sum game if you want to learn more.)

Let’s say there is an active fund with ₹10,000 crore AUM and another active fund with ₹1000 crore AUM. For the larger fund to earn 1% additional return over the market, other active investors need to lose ₹100 crore. But other investors losing ₹10 crore is enough for the smaller fund to achieve 1% additional return. In other words, a smaller fund can outsmart few active investors and earn attractive returns while a larger fund needs to outsmart quite a few active investors.

In theory, it’s easier for a smaller actively managed fund to outperform the market than a larger one. But that’s no guarantee: there are small funds that underperform the market, and also large funds that outperform the market.

AUM’s impact on small and micro cap exposure

The larger a fund is, the harder it is to hold smaller companies. Let’s say a large actively managed equity fund likes a certain small-cap company. But if the company is too small in relation to the fund’s size, the large fund will have to let go of that opportunity. A smaller actively managed fund can invest a sizeable share of its AUM in the same company. This means that larger actively managed funds have constraints that smaller funds don’t. Smaller funds can pick stocks from a relatively larger pool of companies.

How AUM affects passively managed equity funds

A passively managed equity fund simply replicates an equity index. It’s easier for a larger fund to invest money in the prescribed proportions than it is for a smaller fund.

It’s reasonable to prefer a larger index fund over a smaller fund replicating the same index. However, the ability to replicate an index goes beyond just the AUM. An efficiently run smaller index fund can potentially have a lower tracking difference than a larger one. Just like in active funds, the AUM enables certain capabilities, but the fund management team needs to be good enough to benefit from the size advantage.

It is also incorrect to compare AUMs of index funds that replicate different indices. When I began investing in a Nifty 500 index fund, it was relatively small with AUM below ₹500 crore. I still went ahead and invested in that fund because that was the only Nifty 500 fund in the market. To me, choice of the index trumps technicalities such as tracking difference. The fund can grow in size over time, and if it does, any issue caused by low AUM will disappear. But investing in a suboptimal index would mean I’ll have to deal with bigger problems later on.

How AUM affects bond funds

Some people believe that larger bond funds will be able to manage sell-off pressures better than smaller bond funds. That is a myth. Liquidity is directly determined by the quality of the bonds. It doesn’t matter whether a larger fund or a smaller fund is selling those bonds; as long as there are buyers for those bonds, the bonds will sell. Markets don’t care who is selling.

Another myth about bond fund AUM is that a big investor exiting the fund can diminish the fund’s NAV significantly. Such a risk is believed to be lower in larger debt funds. Let’s say 2 bond funds hold a certain bond (i.e, the same ISIN). Let’s say one of the 2 funds sells a huge lot of this bond and drives down the LTP (last traded price) of this bond significantly. Now the other fund’s NAV-which didn’t trade this bond at all-will also fall. Again, the size of the fund does not matter. If your fund holds low quality bonds whose prices can fall badly in a day, you will be affected.

You want to invest in debt funds that hold a well diversified portfolio of high quality bonds. As long as the holdings are good, the size of your bond fund doesn’t matter.

How AUM affects arbitrage funds

In Arbitrage Funds Explained we wrote, “When every arbitrage fund wants to buy futures, who would sell them?”

Does that mean a smaller arbitrage fund is safer than a larger arbitrage fund? No! Irrespective of how big your fund is, the supply of futures needs to come from the market. It is true that a larger fund will need to buy more future contracts than a smaller fund, but that doesn’t guarantee that smaller funds will be able to buy all the futures they need.

The size of an arbitrage fund, i.e. whether it has a large AUM or not, does not matter much. Choose your arbitrage fund based on other metrics and characteristics.

How AUM can affect longevity of funds

Sometimes AMCs give up on small funds that never grow in size. A recent example is DSP Global Allocation Fund of Funds. This fund was introduced in 2014, but the fund was managing only ₹56 crore by the end of Jan 2025. DSP killed this fund off and converted it into a new fund named DSP Income Plus Arbitrage Fund of Funds. We don’t know what really happened, but we can speculate that the AMC gave up on the ‘Global Allocation’ idea.

Let’s put aside the morality of such fundamental changes to an existing fund’s mandate. If the same fund had an AUM of a few thousand crore rupees, we can again speculate, the decision to eliminate the fund would have been much harder for the AMC.

Waiting for small funds to grow large before investing your money is not a bad idea. But no one can tell when, i.e. at what size, a fund becomes large enough to be considered safe.

This discussion won’t be complete without a counterexample, i.e., larger funds ceasing to exist while smaller funds stay on. In 2022, HSBC AMC acquired L\&T AMC. At the time of acquisition, L\&T AMC’s collective AUM was more than 5 times larger than HSBC AMC’s (71,703 crore vs 13,620 crore). Despite being significantly larger, L\&T’s funds got merged into HSBC’s funds. Smaller HSBC funds survived; larger L\&T funds got killed.

Between a smaller and larger fund that are otherwise comparable, we may expect the larger fund to stick around for longer than the smaller fund. But the real world is complex, so nothing is guaranteed.

Note: AMC and fund names are used purely as examples. There is no recommendation for/against any of these entities.