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By Russel Kinnel | 04-27-2010 12:30 PM

When Funds Get Too Big

Turner Investment Partners' David Kovacs on the complications of asset bloat and Turner's asset capacity estimates for different types of funds.

Russel Kinnel: Hi, I'm Russ Kinnel, director of fund research for Morningstar. I'm joined today by David Kovacs, chief investment officer of quantitative strategies at Turner Investment Partners.

David has worked on capacity estimate for Turner, and what that means is they try to estimate how much money they can run in funds. A number of fund companies do this internally, but Turner is maybe the only one I know of that not only publishes that, but even publishes a white paper explaining how they came to that capacity estimate.

David, why don't we start with just what's the point of doing a capacity estimate? What are the bad things that happen if a fund gets too big?

David Kovacs: Sure. The idea is that there is a certain level at which a fund may reach a certain level of assets where it can no longer execute its investment strategy with the same efficiency as it can with a smaller level of assets.

Therefore, it's worthwhile to calculate at what level these funds should close, so that the manager has the potential to maintain his or her potential for excess returns.

Kinnel: If the fund gets too big, it's running the risk of things like trading costs ballooning, asset size getting too big, and the strategy really can just fall apart.

Kovacs: Correct. So what happens is if the asset level gets to be too large for the investment strategy, it may take too many days to either build positions, or too many days to eliminate positions, selling those from the portfolios.

And because you may take longer than ideally that manager would prefer to either buy or eliminate the positions, there is an adverse effect of the price getting too high as the manager buys the stock, or the price getting too low as the manager sells the stock.

So therefore, as the asset size grows to a certain level, the manager is no longer able to buy or sell positions in an appropriate time frame, and as a result of that, performance may lag and sometimes significantly for a long period of time.

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