On the face of it, the largest of the large-cap equity funds have a winning advantage over their smaller counterparts. At least, that’s what the director of Global Research and Design at S&P Dow Jones Indices (SPDJI) sees from the numbers.
“Over the 15-year period ending March 31, 2019, the biggest 25% of active large-cap equity funds managed about 90% of all the assets under management (AUM) held in active large-cap equity funds,” Berlinda Liu wrote in a recent blog post.
While the statistics point to a broad investor preference that skews toward larger funds, they don’t clarify whether larger funds actually do better. As Liu noted, larger funds may be able to hire more skilled fund managers whose track records may attract more assets; on the other hand, smaller funds may face less liquidity constraints in security selection and can potentially “move the needle” with comparatively small investments.
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To explore the effect of AUM on active large-cap equity fund performance, analysts at SPDJI looked at all long-only active large-cap equity funds over 1-, 5-, 10-, and 15-year periods ending on March 31, 2019. They ranked the funds according to size and divided them into quartiles, with the first quartile being the largest. Each quartile was then compared based on net-of-fee returns, volatilities, survival rates, and their ability to outperform the S&P 500.
“Larger funds were more likely to survive the market cycle than their smaller peers, especially over longer horizons,” Liu noted. Looking at the 15-year study period, only a fifth of the smallest 25% of funds that existed at the start of the timeframe survived until the end; in contrast, the largest funds (those in the first quartile) had a survival rate of more than 60%. The pattern of better survival rates among larger funds persisted even in shorter study periods.
The research also found a tendency for larger funds to fare better against the broad equity market. In the 1-year period, around a third of first-quartile funds beat the S&P 500, as opposed to just 25% of fourth-quartile funds. The disparity between the largest and smallest funds got wider over longer horizons, which Liu said is partly due to the low survival rate of smaller funds (“[W]e assume dead funds underperformed the benchmark”).
An examination of the annualized returns and volatilities of all surviving funds revealed that on average, larger funds had higher returns and took more risk than smaller funds in the 1-, 5-, and 15-year periods. But the tendency was less pronounced over longer time horizons: the largest quartile of funds observed over the 15-year horizon generated just 30 bps of extra annualized returns relative to the other three groups
“The 10-year returns and volatilities indicated that large funds were more conservative than their peers during the 2008 financial crisis and its subsequent recovering period,” Liu said.
But third-quartile funds also showed comparable and sometimes even higher returns than those in the top quartile. That aligned with the observation that third-quartile funds sometimes fared better against the S&P 500 than the other three groups, even though they didn’t take extra risk compared to the largest funds.
“Our study shows that, in the large-cap equity fund category, larger funds tended to take more risk and generate higher returns than smaller ones,” Liu said, adding that their main advantage is derived from higher long-run survival rates, which factored into their lower percentage of underperformance relative to the benchmark.
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