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Does Size Matter?
Many mutual funds investors believe that funds whose overall assets are kept to a minimum will provide them with kind of agility that is only found in small. Mutual funds whose size has crept into the billions are perceived as lumbering giants with the inability to react with stealth. And those ideas once had numbers to back them up.
When a mutual fund whose assets increase substantially, purchasing stock on the open market can alter the price of the stock they acquire significantly. The very nature of the positions they take would alter the investment landscape if they were to move into a company whose outstanding shares were too small. What this means is a large mutual fund will look at an investment in relation to the overall contribution to the funds portfolio and performance. The inability to gain a large enough position to make a contribution to the performance would not be possible with smaller companies. A crude comparison comes by way of the dinner plate. In order for a big eater to be satisfied, the portion would have to be significant in relation to the eater's appetite. Watch a big man sit down to drop of mash potatoes and you will understand what I mean.
On the other hand, small mutual funds can create a large position in their fund without purchasing the entire available market of any one company. This agility created a small cap effect, and gave the appearance of better performance than their large cap brethren.
Until Mark Cathhart came along, this evidence was considered by most to be the best selling point on small versus big. In his paper on Mutual Fund Survivorship, he discovered that smaller fund companies have a higher rate of disappearance than larger one do. Some of the underlying reasons for the disappearance of smaller funds is their tendency to risk more on their investment strategies. The upside to this style are outsized returns. The downside, especially if it last for any significant period, means death to the fund. This going "out of business" was, he found, largely ignored in the statistics.
Cathhart took these poor performers from the statistics and found that the returns were relatively even. So what brings a small fund down?
Expenses. Expenses, he found were almost a full percentage point higher than the largest funds charge. The cost of good management, reliable research, advertising, and in general, administrative costs, all ate away at the potential to out-perform. The small-cap effect, as he calls it, was a further strain on performance largely because the smaller the company, the less likely they were to find profitable trading.
Should you avoid small-cap, small sized mutual funds. Not at all. But here is a case of a good string of performance numbers telling a bigger story. If the fund was able to keep itself in the game, then it is probably going o stay there. If the expenses are in line with their larger competition and they are still able to find the best of the small, then it is definitely worth a look. Just be warned.
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