Bigger Isn't Better: Scale Hurts PMS Fund Performance

Large portfolio management services (PMS) are encountering a performance challenge, with five of six schemes managing over ₹5,000 crore seeing their returns diminish as their assets grow. PMS, offering customized portfolios for high-net-worth individuals with a minimum of ₹50 lakh, typically concentrate on a select group of stocks.

This phenomenon points to a structural constraint where deploying larger sums into high-conviction small and mid-cap ideas becomes difficult without influencing stock prices, thus compressing alpha. Data from approximately five years ago, when these schemes were considerably smaller, shows a significantly higher alpha generation compared to their current performance with larger asset bases.

The size-performance trade-off arises from how PMS strategies are built, often favoring small-cap stocks. As assets increase, deploying substantial capital into less liquid small-cap stocks can impact prices, a risk larger funds must mitigate. This often leads larger funds to focus on the top 250-300 stocks, narrowing the investment universe and making consistent market-beating returns more challenging.

While size is a significant factor, other elements like identifying market cycles and selecting the right businesses also influence performance. For instance, strategies leaning on commodities have performed well recently due to the segment's strong performance. However, as corpus grows, particularly in small and micro-cap strategies, stock selection and allocation require a more nuanced approach.

This dynamic has prompted some portfolio managers to shift towards the mutual fund route for more efficient scaling. Investors, while prioritizing performance, should also consider AUM size, fund manager pedigree, and consistency when selecting funds. Very small funds, though agile, may raise credibility and scalability concerns.