Does Size Really Matter?

It is often thought that bigger is better. People are naturally drawn to size, associating strength in numbers. We tend to buy the most popular products. Gymgoers aspire to have the largest muscles. We desire to live in the most spacious house.

However, does the same apply to investing? Does size really matter when it comes to investors performing better?

Large Cap Outperformance

Investing in the biggest-sized companies (referred to as those with the largest market capitalisation) has proven to be a rewarding strategy. Over the past 20 years, the S&P/ASX 200 Index, which tracks the largest 200 companies in Australia, has returned 8.8% p.a. while the smaller S&P/ASX Small Ordinaries Index returned 5.6% p.a.¹

Over in the US, the “Magnificent 7” has driven most of the returns with the S&P 500 Index outperforming the smaller Russell 2000 Index over the same 20-year period.² However, on an annual basis, large cap shares outperform their smaller counterparts ~50-60% of the time.³

If investing in the biggest companies has been the winning trade over more recent times, does that mean that investors should apply the same logic and only invest in the biggest funds?

Is Bigger Better in ETF Land?

We crunched the numbers to find out if we could draw any correlation between fund size and performance. We only looked at exchange traded funds (ETFs) that have a track record of more than five years, and removed leverage and inverse ETFs to control for outliers given the magnified returns.

The Australian ETF market is worth ~$178 billion dollars made up of ETFs ranging in size from a few hundred thousand dollars all the way to nearly $15 billion. Importantly, ETFs do not have capacity constraints with fund size, unlike managed funds which may have to soft or hard-close their funds (more typically in illiquid markets). The open-ended structure of ETFs allows for more units to be created if there is more demand for a fund.

The bigger ETFs tend to be those tracking simple vanilla broad asset classes. These were the first movers in the ETF space in Australia and have gained mass popularity among investors for their core allocations. They comprise 62% of the sample set of ETFs we examined. The more nuanced and innovative strategies, such as thematics and smart beta, have a shorter life span so have not had the chance to accumulate as many assets.

When examining the individual ETFs, there does not seem to be a statistically significant predictability between fund size and performance. Many of the smaller ETFs can perform just as well, if not better than the largest ETFs in the market.

An interesting observation emerges if we group the ETFs into size bands. Given their broad nature, the larger ETFs have a long-term track record of positive returns with smaller variance (known as dispersion). ETFs with over $3 billion in size have average returns of 11.8% p.a. over the past five years. Some of the smaller funds can have a wider dispersion, with those in the $100 million to $500 million band averaging 8.5% p.a. over the past five years with returns ranging between -7.1% and +20.5% p.a.

While past performance is no indication of future performance, one would assume that the larger the fund size, the greater confidence in having a positive return. On the larger end of the scale, funds like Global X Physical Gold (ASX: GOLD) has close to $3 billion in assets and has generated returns of of 8.0% per year over the past five years (as at 31 December 2023).

Investors need be careful on solely relying on size when picking their ETFs. There are a range of other factors in the due diligence kit when assessing ETFs including cost, liquidity and exposure. The ETF also needs to fit into an investors’ overall portfolio to meet their goals.

For example, for investors looking to get exposure to the energy transition and decarbonisation theme, they could consider an ETF such as the Global X Uranium ETF (ASX: ATOM), which although only has $18 million in assets (i.e. a small fund), has not even reached its first birthday and its underlying index has returned 23.9% p.a. over the past five years.⁴

Fund size growth can come from two components – market movements (i.e. performance) and flows (investor demand). Just as the biggest-sized companies are constantly changing, the size of ETFs can also change (for better or worse driven by both performance and flows). For example, the Magellan Global Fund (Open Class) (Managed Fund) (MGOC) was the largest ETF in 2020 and 2021, but has since lost almost 60% of its size.⁵ While leaders can be dethroned, smaller funds can grow in terms of investor demand and strong returns to move up the league table into the larger bands.

Conclusion

Our research has shown that while the largest ETFs have had a good track record of producing positive returns, there is no meaningful relationship to suggest that it’s only the biggest ETFs that can reign supreme in terms of generating high returns.

ETFs with large size are good in nature because as they scale, they can lower trading and operating costs, attract deep liquidity and trading volumes, and have less of a chance of shutting down.

While being the biggest is often seen as a sign of strength, the real success for investors will be choosing an ETF that can fit part of their portfolio to help them achieve their financial objectives and goals. Size does matter, but is not synonymous with high performance.