Once I met a person who was very happy by the fact that he invested his money into a quite famous, one of the biggest and oldest, high ranked mutual fund, and he was anticipating high returns over 10 years. The fund did alright, but its average earnings were not increasing as predicted, and started to follow the market average instead of beating it. Was it a problem with the fund manager? Not likely, the guy is one of the brightest managers on the block.

So, what could be an issue in this case? Some of you may already recognized it, and some - did not, but that’s fine, now you know why you are reading this article

The Size Does Matter
You know that for some things the size does not matter, and for others - does. The size of a mutual fund does matter, because it reveals the ability to purchase stocks and produce good returns on those stocks. Stocks for a fund is like food for a human (sorry for a stupid analogy). When I say “size of a fund”, I mean the total amount of cash, parked in stocks or on hands.

As you already know, a mutual fund is a community of fellow investors who brought their money together, and that situation may create huge amount of cash. At its birth, a fund may start with few million dollars (I will use here dollars as my default currency, however it can be any other currency), and, before closing, the fund may end up with hundreds of billions of dollars.

The Limits Of The Market
The market, as anything else, has it’s own limits: there is a finite amount of shares for each company, and there is a finite amount of shares inside the whole market.

There are unwritten rules that most of the brokers are following to keep the market stable (not talking about the Enron guys ). For example, if all the shares of a company will be purchased by a single person, he may gain the power of the director’s board and may drive company into oblivion. On the other hand, if one person has enough money to buy the majority of shares from single company, and then he dumps (sells) them, the stock price may go down and the company may face financial problems (or even bankruptcy), etc. Fund managers also buy only certain percentage of company’s stock to minimize risks associated with the notorious “do not keep all your eggs in one basket”.

After many years of service, mutual and other funds may find themselves in a situation when they have so much cash, they cannot find any other company to invest into within safe limits of the market stability. When such happens, funds usually do several things: split into smaller funds and change its investment strategy (changing industries or forms of investments, for example, switching from Food into Real Estate)

Too Little Cash
A mutual fund with less then $50 million in the assets is considered a small fund. Small funds are considered not so desirable because they yet do not give enough returns (due to the small margin) to feed the greed of the management team, thus the expenses associated with such funds are much higher. And you know that you don’t want your profits being eaten by the high fund fees! Besides high fees, small funds tend to change their investment objective, create a lot of buy/sell stock transactions which will result in higher annual taxes and fees as well.

Too Much Cash
Over the lifetime of a mutual fund, its assets are growing (and that’s a good thing!), and may exceed a whooping $1 billion mark. When a fund manager has that tremendous amount of cash on hands, the manager sometimes finds him(her)self in a situation when it is not possible to invest all the money! And that’s even a bigger problem then losing the money in a market dive…

Inconvenient truth: a fund makes its best when all the cash is working hard for its owners. The situation when a huge amount of cash is simply parked in a bank account may increase the management fees and decrease the total fund returns against the total cash mass.

A smart manager will close the fund to new investors when assets will reach the certain limit, which will depend on the manager’s lucky number. That will semi-freeze the asset growth from the new incoming cash, and will make the fund a private club. Sort of.

The Perfect Fund Size
The perfect fund size that will put all your money into the job of money making is the safe range of between $50 million and $1 billion in assets. That range is not invented by me, but mentioned in many books and resources.

In the perfect world, you would join a fund with about $100 million assets, and that fund wont accept new investors after yourself, thus the assets will not grow by the cash in-flow from new investors but from the stock profits. Such perfect scenario would make you a very rich person in no time…

Get In Early
New funds are created every month, they start small as a newly born fund, or they start bigger from the older fund splits (old and fat funds can be split to inject new life into the huge amount of cash they accumulated). Look for young but mature funds in the lower to middle asset size, and don’t forget to look at the fund manager’s past success stories.

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