Asset management companies that try to deter investors from putting new money into their funds are like turkeys voting for Christmas. The managers' revenues are usually directly linked to the amount of money in their funds, so they tend to want to grow them as fast as possible.
But last week First State Investments joined that rare breed trying to put investors off when it announced it would impose the full initial charge of 4 per cent on its £750m Asia Pacific and £450m Global Emerging Markets funds, both managed by the highly rated Angus Tulloch. First State doesn't want any more cash invested in these funds but can't close them to new business because they are open-ended. So instead it is raising the initial charge from 0 per cent as a deterrent.
First State's move shows that rapid growth in the size of funds can lead to a change in their investment approach and a downturn in performance. If a manager has too much money to invest, he may have to start buying companies he regards as second- division stocks. Or he may be penalised when he wants to sell relatively illiquid stocks as the bid-offer spread widens.
Mr Tulloch argues that it is now necessary to limit the growth of his two funds because small-cap stocks in Asia and emerging markets have become less attractive. If the funds had grown any larger, he would have had to invest the new money in large caps instead. "This would change the character of the funds and they would not be the funds existing investors had bought into," he says.
As a result, First State is launching the Asia Pacific Leaders and Global Emerging Markets Leaders funds, in which Mr Tulloch will invest only in stocks with a capitalisation of over $1bn [£600m] each. There will be 30 to 60 stocks, against 80 to 90 in the existing funds.
First State's move is unusual but not unprecedented. Last year, for example, management house Schroders raised the initial charge on its top-performing US Small Companies fund after the manager, Ira Unschuld, said he could not manage more than the combined $1.65bn he ran across all his funds. Schroders reduced the charge again when Jenny Jones replaced Mr Unschuld earlier this year. She believed the level of assets was compatible with her investment approach.
Jonathan Harbottle, managing director of investment house Liontrust, says: "Fund management companies should limit the amount of money in their funds. We believe liquidity becomes a major issue about halfway down the mid-250 index in the UK.
"Limiting the amount under management will benefit investors and shareholders in the long run as performance will be better. The performance of very large funds can tail off as they become nothing more than closet index trackers."
Mr Harbottle adds that what should be seen as the maximum size of a fund changes in line with liquidity conditions. "Three years ago, we felt we could grow to £15bn under management when the FTSE was approaching 7,000 points. If the market stays at current levels, we will have to stop taking new money at £6bn to £7bn, while we currently have £4bn."
Robert Burdett, joint manager of the multi-manager service at Credit Suisse, says size is one of many factors considered by the firm when choosing funds for portfolios.
"It is not just the number of assets in a fund that investors need to consider," he says. "It is the number of funds that a manager runs, whether they have different mandates and how much time he can spend on each one.
"If he finds a stock he likes, can he put it into all his portfolios or does he have to decide which funds to place it in? Each fund has reporting requirements which take up the manager's time."
Investors also need to consider the strategy of the manager. Mr Burdett says he has withdrawn from funds, or not invested in them in the first place, because he has felt they have too many assets or the manager has had to change his investment approach as a result of taking on new money. Nevertheless, he adds that if a good-quality manager takes on a more mainstream approach, it may be worth keeping him in the portfolio.
To take advantage of the potentially more nimble reactions of small funds, Mark Dampier, head of research at independent financial adviser Hargreaves Lansdown, says investors should follow top-performing fund managers.
"It was clear that when Tim Russell and Frank Manduca launched their funds at Cazenove and UBS respectively, they would outperform because they only had relatively small amounts of money to manage," he says. He believes that Invesco Perpetual European Growth accepted too much money in the spring of 2000 when it was managed by Rory Powe.
Between 1 April 1997 and 3 April 2000, the fund produced a return of 213.68 per cent compared to the sector average of 101.46 per cent, according to ratings agency Standard & Poor's, making it the top-performing fund.
But this all changed between 3 April 2000 and 1 April 2003: the fund fell by 68.05 per cent, compared with an average fall of 46.84 per cent across the sector, making it the worst performer.Reuse content