Size isn’t everything

Is size the be-all and end-all when it comes to investment funds? If you listen to some in the investment industry, the answer appears to be yes. There is a growing clamour for smaller investment companies to merge with one another, or shut up shop completely. Small funds – those worth less than £250 million, say – are no longer viable, the critics claim.

Nonsense. There are plenty of well-run small funds delivering excellent returns for shareholders in return for competitive charges. Many of these funds trade on reasonable valuations; some offer investors a value proposition they simply wouldn’t be able to get anywhere else – access to a specialist asset class, for example.

The annoying thing about this debate is that the case against smaller investment companies has little to do with the funds themselves. Rather, it focuses on changes in the wealth management industry, where consolidation has led to the dominance of a handful of larger players. These big wealth managers are cautious about smaller investment companies because their size means they place big bets; they fear these bets will move the share prices of smaller funds against them.

Fair enough. But does the fact one group of potential investors in a fund may not feel comfortable mean all investors should miss out? You might, in any case, point out that wealth managers are hardly doing their clients a service if their size means they sometimes have to pass on attractive investment opportunities.

In the end, of course, the rights and wrongs of this debate are irrelevant. What investors care about is performance. But the truth is that there’s no evidence smaller funds can’t deliver, even with the potential headwind that their exclusion from wealth managers’ buy lists could represent.

Take the thorny question of discounts. It is the case that shares in smaller investment companies trade, on average, at a wider discount to the value of their underlying assets. But the comparison is misleading, because a handful of very large funds on narrow discounts distort the picture. Strip out these mega investment companies and there’s not much difference between smaller and larger funds.

Certainly, there are some smaller investment companies that have disappointed, on portfolio performance, on discounts, or on both. But investment company boards are far more proactive than in the past – we’ve seen a wave of corporate action to address such failures. More funds are merging, changing their investment manager or simply winding up.

Moreover, smaller investment companies have certain advantages that it would be a mistake to overlook. At a general level, there are plenty of examples of large funds where managers have struggled to cope with unwieldy portfolios. But more specifically, the fact small funds can make modest investments can be a real virtue in illiquid asset classes – from new areas such as green energy to established areas of the market such as smaller companies. Their agility is often very valuable.

Finally, bear in mind that while wealth managers are important, they’re not the only investors out there. Retail investors buying on their own account, as well as smaller institutional investors, are also shareholders in investment companies. They can make a market for smaller funds where wealth managers are opting out.

In the end, irrespective of size, every investment company will be judged on the performance it delivers. In which case, it’s worth spending a few minutes looking at the Association of Investment Companies’ online statistics. Whichever sector you choose to compare, you’ll find that the top performers include a significant number of smaller funds that the critics tell us shouldn’t exist. Long may that continue.