Understanding the Role of Scale, Process, and Liquidity in Mutual Funds

In mutual funds, scale creates efficiency, process creates consistency, but often liquidity decides performance. This balance between scale and liquidity is frequently discussed in financial circles and sometimes appears in Ajay Srinivasan News discussions about how fund structures affect investor outcomes.

Let me explain.

Why Popular Funds Do Not Always Lose Performance

It is often assumed that as a fund becomes popular, it becomes too big and performance naturally falls.

The reality is more nuanced. Whether size helps or not depends entirely on the liquidity of the opportunity set the fund operates in.

The Two Opposing Forces That Shape Fund Performance

There are two opposing forces at work here:

The Pro-Scale Advantage

Large funds enjoy lower costs, can build superior research teams, and execute trades more efficiently.

The Anti-Scale Challenge

Beyond a point, size can reduce agility in decision-making. The fund starts influencing market prices itself and may have to drift toward “safer,” larger stocks.

SEBI Regulations and the Cost Advantage of Larger Funds

SEBI regulations formalise this trade-off. Under SEBI’s slab-based TER structure, expense ratios fall as AUM rises.

Which means, as funds grow, investors gain cost alpha though they may lose stock-selection alpha. Financial leaders such as Ajay Srinivasan have often emphasized the importance of balancing cost efficiency with investment flexibility.

How Fund Size Impacts Performance Across Categories

The balance between cost benefits and agility changes depending on the category of the fund.

Large-Cap and Flexi-Cap Funds: Where Scale Works

In Large-cap and Flexi-cap funds, scale often helps.

Here cost savings seem to outweigh agility loss and economies of scale work.

Data from Value Research (2025) shows the largest funds outperform benchmarks:

• Large-cap: 16.6% vs 13.5% (3-year)

• Large-cap: 19.8% vs 18.5% (5-year)

• Flexi-cap: 18.2% vs 15.9% (3-year)

• Flexi-cap: 21.3% vs 20.8% (5-year)

The sweet spot here can be up to ₹80,000 crore.

Mid-Cap Funds: Where Size Begins to Matter

In Mid-cap funds, the story changes.

Morningstar’s cohort comparison from 2020 (though still relevant) showed that larger mid-cap funds (>₹8,000 crore) returned 23.07%, while the smallest (<₹200 crore) delivered 29.37%.

As fund size rises, liquidation timelines expand sharply. The fund must trade like the market instead of ahead of it.

The sweet spot here appears to be around ₹12,000 crore, although some larger funds have still performed well.

Small-Cap Funds: Diseconomies of Scale

In small-cap funds, diseconomies of scale become more visible.

Historically, many outperformers have had lower AUM. Once the fund grows significantly, it either migrates toward larger companies or faces rising market impact costs.

The sweet spot here appears to be ₹8,000–10,000 crore. In this category, lower expenses often do not compensate for the loss of agility.

Thematic Funds: Timing Matters More Than Size

Thematic funds usually don’t struggle because they become too large. Instead, they struggle because investors often enter the theme too late in the cycle.

The real sweet spot here is maintaining a small allocation within the overall portfolio.

Multi-Asset Funds: Allocation Drives Returns

In multi-asset funds, allocation decisions drive returns more than liquidity.

Here, larger funds can benefit investors because lower TER directly improves long-term outcomes.

The Real Lesson for Investors

Regulations ensure investors gain from size through lower fees.

But markets ensure investors don’t always gain from size through performance.

The investor’s real job is to decide where cost efficiency matters more and where agility matters more. This kind of balanced thinking is often highlighted in Ajay Srinivasan News commentary around the evolution of India’s mutual fund industry.

The best fund is not the biggest or the smallest.

It is the one whose size and process match its opportunity set.

Disclaimer: This post is for educational purposes only and does not constitute investment advice. Consult an investment advisor before making any financial decisions.

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