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One of India’s top-performing equity mutual funds recently crossed ₹1 lakh crore in assets under management (AUM), a remarkable achievement. While this is a strong indicator of investor trust and consistent past performance, it also raises an important question in the minds of many investors: Will a higher AUM lead to lower returns in the future? Let’s Break It Down. Let’s unpack this concern across different fund categories.

In categories such as large-cap, flexi-cap, and mid-cap, a rising AUM typically does not have a significant negative impact on fund performance in the long term. These funds invest in well-established companies with large market capitalizations and high liquidity, allowing fund managers to deploy larger amounts of capital without affecting the stock price significantly.

For example, in a large-cap fund, the manager can comfortably increase allocation in companies like Infosys or HDFC Bank without liquidity concerns. These stocks can absorb large trades, and the fund can scale its holdings while staying within SEBI's 10% exposure cap per stock.

Even in flexicap and midcap funds, where there is some exposure to smaller companies, liquidity and fundamental quality remain relatively strong, making it easier for fund managers to manage a growing corpus.

Parag Parikh Flexi Cap Fund became the first equity mutual fund in India to cross ₹50,000 crore in AUM (as of December 2023), and has now crossed ₹1 lakh crore, a remarkable achievement. Yet, despite this rapid growth in size, the fund continues to deliver strong performance and remains among the top-performing flexi-cap funds in the industry.

Similarly, HDFC Flexi Cap Fund, another fund with a large AUM, continues to perform well within its category.

Both Parag Parikh and HDFC Flexi Cap Funds have continued to outperform the index and category average, even after becoming large in AUM. These examples show that as long as a fund maintains a disciplined investment strategy and a consistent approach, high AUM does not necessarily hinder returns, especially in categories like flexi-cap, where there is greater flexibility in stock selection and allocation.

Take the midcap segment, for example, funds in this category are required to invest at least 65% in midcap stocks. HDFC Midcap Opportunities Fund has the highest AUM in this segment, yet it continues to be one of the top performers. This shows that high AUM alone doesn’t hinder performance when managed well.

In a recent interview with Value Research, Chirag Setalvad, Head of Equities at HDFC Mutual Fund and fund manager of the HDFC Midcap Fund, addressed the concern around fund size and performance. He said:

“Size is not the determinant of returns. Over the past decade, we’ve been the largest fund in the midcap segment and have experienced the best, average, and even the worst performance, while still maintaining our position as the largest. At one point, we were 2.5 times the size of our next peer, and today we're about 1.5 times, and still doing well. Our fund size is only about 0.7 to 0.8% of the total midcap market capitalization, which means there is still ample room for growth.”

This reinforces the view that AUM alone doesn’t dictate a fund’s success; strategy, discipline, and execution do.

Let’s take a closer look at the two largest AUM funds in the small-cap segment.

Despite managing significantly large corpus, two small-cap funds have continued to deliver competitive returns and maintain strong portfolios. This shows that even in the small-cap space where liquidity and stock selection are more challenging, a large AUM doesn’t automatically mean poor performance, provided the fund house has a robust research process and a disciplined approach.

However, it’s important to note that managing large AUMs in the small-cap segment does come with limitations. Fund managers need to be more selective, spread investments across a broader set of quality companies, and carefully manage liquidity risks.

Nippon India Small Cap Fund and Quant Small Cap Fund have the largest AUMs in the small-cap segment, yet both continue to deliver some of the best returns in the category.

In an interview with Mutual Funds with Groww, Samir Rachh, Fund Manager of the Nippon India Small Cap Fund, acknowledged that managing a large AUM in the small-cap space comes with its challenges, primarily due to liquidity constraints in small-cap stocks. However, he explained that the fund manages this risk by diversifying across a larger number of stocks and sectors, which helps improve the fund’s risk-adjusted returns.

He also mentioned adopting a blend of investment styles, including both value and growth, to create a well-balanced and diversified portfolio. This multi-pronged approach allows the fund to scale effectively without compromising on performance.

Smallcap Funds: AUM Growth Can Pose Real Challenges

These funds focus on companies with market capitalizations typically below ₹5,000 crore, many in the ₹1,000–1,500 crore range. Such companies tend to have lower trading volumes and less institutional coverage, making them harder to buy or sell in large quantities.

As a small-cap fund's AUM increases, the fund manager faces a few key challenges:

Limited Liquidity:

It becomes harder to enter or exit positions without moving the market price.

Need for Broader Diversification:

The manager must identify more fundamentally sound and liquid small-cap companies to spread the corpus, which is not always easy in a relatively limited universe.

Reduced Flexibility:

With a larger fund size, it becomes more difficult to take meaningful positions in smaller companies without breaching ownership or liquidity limits.

In short, a growing AUM in a small-cap fund can lead to operational constraints and reduced agility in portfolio management.

India’s Market Is Expanding:

While high AUM can introduce challenges, especially in the small-cap space, India’s capital markets are also evolving rapidly. More companies are getting listed, and the overall market capitalization is growing. This expansion broadens the universe of investable companies, providing fund managers with more opportunities to find quality businesses across segments.

Moreover, top AMCs with strong research teams and disciplined processes are well-equipped to manage larger AUMs, even in complex spaces like small caps. For investors, this means that while it’s important to be cautious about AUM size, it shouldn’t be the only factor in selecting a fund.

Final Thoughts:

While large AUM may pose some short-term challenges, especially in terms of execution, it is unlikely to impact performance over the long term, as long as the fund maintains a disciplined investment approach and strong stock selection process.

Yes, a rising AUM can bring certain challenges. However, historical data and real-world examples show that AUM alone doesn't determine a fund's success. When a fund is managed by a skilled fund manager who sticks to his investment philosophy, makes necessary adjustments in strategy, and focuses on disciplined execution, high AUM does not become a barrier to performance, regardless of the fund category.

Ultimately, it’s the quality of fund management, not the size of the fund, that makes the difference.

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Disclaimer:

The information provided in this blog is for informational purposes only and should not be considered financial advice. Please consult with a financial advisor before making any investment decisions.