Fund size and returns on the JSE

Abstract

Market sentiment, the popular press and academia are divided on the question of whether the size of a fund affects its performance. This study examines the issue by constructing hypothetical portfolios of varying sizes, using historical data for each of the years 1991 to 2008. Each portfolio consisted of 40 randomly selected stocks, chosen from an investment universe of the top 160 JSE listed shares in terms of market capitalisation. Rules were applied to limit the concentration of any particular share and to ensure that trading volumes were practical. Simulation was then used to explore the boundaries of possible returns for each portfolio. The results of the simulation indicate that a fund's size is a contributing factor to its performance; liquidity being the underlying reason for this relationship. Performance was found to be affected for fund sizes greater than about R5bn. Large funds are increasingly forced towards market-cap weightings with a resulting concentration in resource stocks. The relevance of these findings to the South African fund management industry is that large funds should switch to passive investment strategies. Small to medium sized portfolio managers must be aware of the size effect and ensure that their funds are 'capped'.