the fund that got too big to beat the index

A friend forwarded me his mutual fund's factsheet last week, a little deflated.

For about ten years this thing beat its index by roughly four points a year. Properly good. Then he pointed at the last three years on the same chart. Flat. Dead in line with the benchmark. Same manager the whole time, same process, same star rating on every app. He wanted to know what broke.

I asked him one question. How big is the fund now.

Here is the part the factsheet never prints. When that fund was small, say Rs 500 crore, its highest conviction midcap idea could sit at six percent of the book. That is a Rs 30 crore position. A manager builds that in a couple of days and it actually moves the fund's number.

The good years pulled money in. It now runs around Rs 40000 crore. That same six percent conviction is a Rs 2400 crore order. You cannot fill that in a midcap without becoming the price yourself, and you would need months of the stock's entire traded volume to get there. SEBI caps any fund at ten percent of a single company on top of that, so on a Rs 8000 crore midcap the absolute ceiling is Rs 800 crore. The idea that made his numbers gets shaved down to a rounding error, or dropped.

So the fund does the only thing it can. It drifts into the top twenty large caps everyone already owns and quietly becomes the index it used to beat, while still charging an active fee.

None of this is the manager getting worse. The money found the track record and competed it away. The academics call it diseconomies of scale, and it bites hardest exactly where the good ideas are hardest to buy in size.

Before you read a fund's returns, read its assets next to its mandate. Ask whether it is still small enough to do the thing you are paying it to do