By overlooking funds with a small corpus size, you could miss out on many outperformers.

Investors tend to follow the crowd when it comes to putting their money in mutual funds. The attraction for the largest fund in the category is the greatest. However, small-sized funds that have consistently given attractive returns are also worth a dekko. It is time you started going by the returns rather than the corpus.

Small funds, large returns

Many small funds, with a corpus of less than `500 crore, boast of a stellar track record. The table includes funds that have not only beaten their category average but also the largest-sized fund in their category over the past one year. The high rating indicates these funds have given sound risk-adjusted returns over the long term.

However, despite their good performance, many of these funds have failed to attract substantial inflows. L&T India Value Fund's average asset under management (AUM) stands at `162.54 crore today compared to `43.91 crore a year earlier. A considerable portion of the growth in corpus has come from the 82.14% return the fund has earned over the past one year. Inflows into the fund have not been high.

Advantages of small size

Small-sized funds are nimble and can move in and out of stocks quickly. A large fund takes more time to build a big enough position in a stock for it to make a difference to its performance. Small funds also don't suffer as much from `impact cost'. When a large-sized fund starts buying a large number of stocks, its purchases drive the stock's price up, so that the fund's average cost of purchase becomes higher. Similarly, its massive selling drives the stock's price lower.

If you want exposure to a pure mid-cap fund, you may be better off choosing a relatively small fund. When the corpus is small, mid-cap funds invest entirely in mid-cap stocks. But when the corpus grows, as much as 35-40% of the corpus gets invested in largecap stocks due to which the fund becomes more like a multi-cap fund.

Earlier, one risk of investing in small funds was that it could be merged with another. If you had invested recently, such a transaction could give rise to short-term capital gains tax liability. However, the 2015 Budget has proposed that fund mergers will no longer attract tax liability for investors.

Disadvantages and risks

The downside is that the expense ratio tends to be higher in smaller funds. As asset size grows, per investor expense comes down in a large fund. A very small sized fund is also susceptible to liquidity pressure. If a fund's size is very small, its performance could get affected by high redemption pressure. During downturns, as investors stampede for the exit, funds pay them out of their cash holdings. If the fund is too small, its cash reserves will be limited and it will be forced to sell its equity holdings. This could affect its future performance. Financial planners suggest the following minimum AUM: `100 crore in case of equity and balanced funds and `250 crore in case of income funds.

What should you do?

Clearly investors need to look beyond a fund's AUM. A fund's AUM should not be the primary criterion for selection. Investors should pay more attention to a variety of qualitative and quantitative parameters. Her firm's selection methodology includes parameters like past performance, expense ratio, ability to withstand downturns, strategy during bullish and bearish phases, etc. On the qualitative side, an investor should ensure that the fund manager has a sound track record. The fund should stay true to its mandate. Ensure that the fund has remained true to its stated investment philosophy. By limiting your search to only the bigger funds, you may be overlooking many greenhorns that could well become tomorrow's stalwarts.