Does size hurt mutual fund Returns? What the data says about India’s biggest equity funds

There is a question that most mutual fund investors never think to ask. When a fund has performed brilliantly and grown to Rs 50,000 crore or Rs 1 lakh crore in assets, does that very success make it harder to keep delivering? The answer, backed by both decades of academic research and live Indian market data, is yes and understanding why matters enormously for how you think about fund selection.

What the Research Established

A landmark study by Chen, Hong, Huang and Kubik, published in the American Economic Review, examined over 3,400 US mutual funds across nearly four decades from 1962 to 1999. The finding was unambiguous:

Fund performance declines as fund size increases, both before and after fees.

A two-standard deviation increase in fund size translated into a 65 to 96 basis point (0.65% to 0.96%) reduction in annual returns. That is not a rounding error. For a fund already struggling to beat its benchmark, nearly one percentage point of annual drag from size alone is meaningful compounding erosion over a decade.

The mechanism is straightforward.

When a fund is small, a manager can concentrate capital on their best ideas.

When a fund swells to tens of thousands of crores, every trade moves the market against the fund. Buying a position large enough to matter becomes expensive.

Selling becomes equally costly. The fund is forced to hold more stocks, including its second and third-tier ideas, simply to deploy capital. This is the liquidity problem and it hits hardest in small and mid-cap funds, where stocks are inherently less liquid and price impact is severe.

Interestingly, the same research found that fund family size helps rather than hurts.

Larger fund houses get better trading commissions, earn higher securities lending fees and can spread fixed costs more efficiently. The problem is fund-level size, not house-level size. A large AMC running multiple focused funds can preserve performance better than a single bloated fund trying to do everything.

What India’s Data Shows

Taking the largest 300 equity mutual funds in India by AUM and examining their average returns produces a clear picture of where things stand today.

The average return across these 300 funds: -8.27 per cent over six months, 3.85 per cent over one year, 3.34 per cent over two years, 15.77 per cent over three years, 14.16 per cent over five years and 14.21 per cent over ten years.

These are not bad long-term numbers in absolute terms, but they need to be read in context of what the market itself delivered over those periods and how the largest individual funds compare.

Now look at India’s ten largest equity funds by AUM and their performance alongside it. All return figures are annualised.

Several patterns emerge immediately.

The one-year returns across virtually every large fund are poor ranging from 1.83 per cent to 10.25 per cent, with most clustered between 3 per cent and 5 per cent. This reflects a difficult market environment over the past year and is not a fund specific failure. But the dispersion over longer periods is where the size story becomes visible.

SBI Large Cap at Rs 55,246 crore has delivered 11.38 per cent over three years and 10.67 per cent over five years meaningfully below the 300-fund average of 15.77 per cent and 14.16 per cent respectively. With 81.69 per cent in large caps, 45 stocks and a beta of 0.92, this is a fund that closely mirrors its benchmark but struggles to add alpha at scale. Its Sharpe ratio of 0.17 and alpha of 0.09 confirm limited active contribution.

ICICI Prudential Large Cap at Rs 77,452 crore tells a similar story — 14.57 per cent over three years and 13.77 per cent over five, both below the broader average. With 68 stocks and 84 per cent in large caps, the fund is essentially a high-cost index tracker at this scale.

Contrast this with HDFC Mid Cap at Rs 94,257 crore which despite being the third largest fund has delivered 22.31 per cent over three years and 19.92 per cent over five, both well above average. But look at the portfolio: 78 stocks, 61.64 per cent in mid caps and only 13.73 per cent in large caps. The mid and small-cap tilt has kept performance alive. The question is whether this can continue as the fund grows further.

The research is explicit — size hurts most precisely in mid and small-cap funds where liquidity constraints bite hardest. HDFC Mid Cap is already at Rs 94,000 crore. That is an enormous amount of money to deploy in a relatively illiquid segment.

Nippon India Small Cap at Rs 67,642 crore with 244 stocks is an even more extreme example. To manage that AUM in the small cap space, the fund holds nearly 2.5 times as many stocks as the average large cap fund. That diversification is forced, not chosen. When you need to deploy Rs 67,000 crore into small cap stocks without moving prices against yourself, you end up owning practically the entire small cap universe. At that point, the fund’s returns will increasingly converge toward the small cap index itself with a higher expense ratio on top.

The Organisational Dimension

Beyond liquidity, the research points to something less discussed: organisational drag.

As funds grow, decision-making structures become hierarchical. A single manager running a focused fund with full conviction in 30 to 40 stocks can act decisively. A large fund with co-managers, committees and approval chains introduces what researchers call hierarchy costs: ideas get diluted, conviction gets averaged down and the processing of qualitative, relationship-based information about companies becomes harder to act on quickly.

The data supports this. Solo-managed funds in the research outperformed co-managed ones by approximately 48 basis points annually after controlling for size.

Notice in the Indian data that Parag Parikh Flexi Cap, which maintains a concentrated philosophy with 78 stocks, has delivered the one of the highest 10-year returns in this list at 16.83 per cent despite being the largest fund at Rs 1.34 lakh crore. Its alpha of 0.44, Sharpe of 0.36 and beta of 0.62 reflect a genuinely differentiated portfolio. The fund’s willingness to hold international equities alongside domestic names has also helped manage the liquidity constraint domestically.

What This Means for Investors

None of this means large funds are bad investments. Over a ten-year horizon, even the weakest performer on this list — SBI Large Cap at 11.96 per cent has compounded meaningfully. But it does mean that chasing a fund because it is large, popular and heavily marketed may not produce the best outcomes.

Size is a structural headwind, not a dealbreaker. But as AUM grows, the hurdle for alpha rises. For investors in mid and small-cap funds specifically, monitoring AUM growth is not optional, it is essential. A fund that delivered 25 per cent returns with Rs 5,000 crore will face a fundamentally different execution challenge at Rs 50,000 crore in the same universe of stocks.

The right question to ask before investing in any large fund is simple: given its current AUM, can this fund still access the opportunities that drove its historical performance? If the answer requires honest examination of how much market impact the fund creates every time it buys or sells, that examination is worth doing.

In case you need a further nudge on how to think about size, here’s a quote from Warren Buffett:

“Our future rates of gain will fall far short of those achieved in the past. Berkshire’s capital base is now simply too large to allow us to earn truly outsized returns. If you believe otherwise, you should consider a career in sales but avoid one in mathematics (bearing in mind that there are really only three kinds of people in the world: those who can count and those who can’t).”

Happy investing.

Disclaimer: This article is for informational purposes only and not investment advice.

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