AUM (Assets Under Management) Explained

When you walk into a sweet shop in Delhi’s Chandni Chowk, you instinctively gravitate towards the vendor with the longest queue. There’s wisdom in crowds, isn’t there? The same principle applies when you’re choosing mutual funds – the size of a fund’s Assets Under Management (AUM) tells you a story that goes beyond just numbers.

AUM represents the total market value of all investments that a mutual fund manages on behalf of its investors. Think of it as the size of the financial pot that the fund manager is stirring. But here’s where it gets interesting – the size of this pot can dramatically affect your returns.

What Exactly is AUM?

AUM is calculated by adding up the current market value of all securities held by a mutual fund scheme. If a fund holds shares worth ₹500 crores, bonds worth ₹300 crores, and cash worth ₹200 crores, the total AUM stands at ₹1,000 crores. This figure changes daily as markets move up and down, and as investors add or withdraw money.

The calculation seems straightforward, but the implications run much deeper. A fund’s AUM directly impacts everything from its expense ratio to its ability to execute investment strategies effectively.

Why AUM Size Creates a Goldilocks Problem

Just like Goldilocks searching for the perfect porridge, investors need to find funds with AUM that’s neither too big nor too small, but just right. Here’s why size matters so much:

1. Small Funds Face Growing Pains

Funds with AUM below ₹100 crores often struggle with high expense ratios. When a fund’s operational costs get spread across a smaller asset base, each investor bears a higher burden. Imagine splitting the bill for a family dinner between three people versus ten – the per-person cost changes dramatically.

Small funds also face liquidity constraints. If the fund manager wants to buy a particular stock worth ₹10 crores but the fund’s total AUM is only ₹50 crores, this single investment becomes 20% of the portfolio. Such concentration can be risky.

2. Large Funds Hit the Efficiency Wall

On the other end, funds with AUM exceeding ₹10,000 crores start facing what economists call diseconomies of scale. When a large-cap fund with ₹15,000 crores AUM wants to buy shares of a mid-sized company, it might end up owning 5-10% of that company just to make a meaningful impact on its portfolio.

This creates two problems. First, such large purchases can push up the stock price, making the fund’s own buying more expensive. Second, when it’s time to sell, large funds can struggle to exit without depressing the stock price.

3. The Sweet Spot Advantage

Funds with AUM between ₹500 crores and ₹5,000 crores often operate in the sweet spot. They’re large enough to negotiate better brokerage rates and spread operational costs effectively, yet small enough to remain nimble in their investment decisions.

How AUM Impacts Your Investment Returns

The relationship between AUM and returns isn’t just theoretical it shows up in your portfolio performance in several ways:

1. Expense Ratio Efficiency

Larger funds typically offer lower expense ratios because fixed costs get distributed across a bigger asset base. A fund with ₹10,000 crores AUM might charge 1.5% annually, while a similar fund with ₹500 crores might charge 2.2%. Over time, this 0.7% difference can significantly impact your wealth creation.

2. Market Impact Costs

When large funds buy or sell securities, they often move market prices. This market impact cost gets reflected in reduced returns for investors. Smaller, more agile funds can enter and exit positions without significantly affecting stock prices.

3. Investment Universe Limitations

Large funds often get restricted to investing only in large-cap stocks because mid and small-cap stocks don’t have enough liquidity to absorb their investments. This limitation can reduce the fund’s ability to generate alpha during market cycles where smaller companies outperform.

AUM and Different Fund Categories

The optimal AUM varies significantly across fund categories:

1. Large-Cap Funds These funds can handle AUM of ₹5,000-15,000 crores because they invest in highly liquid large-cap stocks. Beyond this size, even large-cap funds start facing constraints.

2. Mid and Small-Cap Funds These funds work best with AUM between ₹500-3,000 crores. Higher AUM forces them to either hold too many stocks (leading to index-like returns) or invest in less attractive opportunities.

3. Sectoral and Thematic Funds These specialised funds should ideally have AUM below ₹2,000 crores because their investment universe is limited to specific sectors or themes.

Red Flags to Watch Out For

Rapid AUM growth can sometimes signal trouble ahead. When a fund’s AUM doubles within six months due to strong recent performance, it might struggle to deploy the new money effectively. The fund manager who was selecting 30-40 stocks from a universe of 500 companies might suddenly need to pick 60-80 stocks to accommodate the larger corpus.

Similarly, consistent AUM decline over 12-18 months might indicate investor dissatisfaction with performance or strategy changes.

Practical Decision-Making Framework

When evaluating mutual funds, consider AUM alongside other factors. A mid-cap fund with ₹8,000 crores AUM might be too large, regardless of its past performance. Conversely, a large-cap fund with ₹200 crores AUM might be too small to be cost-effective.

Check the fund’s AUM trend over the past two years. Steady growth indicates investor confidence, while volatile AUM suggests investors are unsure about the fund’s strategy.

To Sum Up

AUM serves as a crucial indicator of a fund’s operational efficiency and future return potential. The right AUM size varies by fund category, but the principle remains constant  you want funds that are large enough to be efficient but small enough to remain agile.

Before investing, check the fund’s current AUM and compare it with similar funds in the category. This simple step can help you avoid funds that might struggle due to size related constraints. Remember, in the world of mutual funds, bigger isn’t always better  optimal is what you should aim for.