Speaking at a T. Rowe Price roadshow event in Sydney yesterday, Lonsec executive manager for investment consulting Michael Elsworth focused on the question of “how big is too big” when it comes to capacity constraints.
As funds under management (FUM) increases for Australian equity managers, Mr Elsworth said, alpha (that is, outperformance due to active manager skill) tends to decrease.
However, the typical analogy about capacity – that is like an overinflated balloon that eventually “pops” – is a little misleading, he said.
“We prefer to think of capacity in horse racing terms. Capacity is like adding weight or putting a bigger jockey onto a horse. There’s eventually a point at which the horse won’t be able to win if you keep adding more and more weight,” Mr Elsworth said.
“Eventually there will come a point in time where a manager has too much money and won’t be able to add value,” he said.
Researchers like Lonsec tend to use a rule-of-thumb: 1 per cent of the market capitalisation of the ASX200 as a limit for fund manager capacity, Mr Elsworth said.
The ASX200 currently has a market cap of $1.7 trillion. One per cent of that is $17 billion, so that’s the starting point,” he said.
However, there are number of other factors that Lonsec takes into account, including turnover, number of stocks in the portfolio, active share, market capitalisation of the asset class, and style, he said.
Additionally, there are also indications that an Australian equities manager could be under capacity pressure if it sees increases in its time to trade, average trading costs, and average time to liquidate its portfolio.
“All of those things can be – if they increase over time – that can be an indicator that a manager is struggling with its size,” Mr Elsworth said.
“They can all affect our conviction levels. And ultimately they can lead to a ratings downgrade – and that has certainly happened recently, where we’ve downgraded managers primarily for capacity considerations,” he said.
In response to questions from InvestorDaily, a spokesperson for Lonsec said Fidelity’s Australian equities strategy was downgraded recently, with one of the issues being capacity concerns.
Lonsec also monitors capacity at large Australian fund managers like IFM Investors, BT Investment Management and State Street Global Investors, said the spokesperson.
