According to Statista (see chart below), the 10 largest asset management companies manage approximately 30% of the world's assets under management as of June 2024. And it's unlikely that this concentration of assets has fallen over the past two years. How can we explain such a craze for management behemoths? Among the reasons put forward are the near-obligation of pension schemes and sovereign wealth funds to favour size (notably for reasons of leverage ratio), the sense of security and stability offered by large management houses, the reduced need for detailed operational due diligence when managers are part of well-established groups, and the fact that fund selectors minimise their career risk when they favour funds held by the masses. But are they on the right track?

The process seems to be well established among most institutional investors, independent asset managers and banks: the first step in the fund selection process is to narrow down the investment universe to vehicles that have been in existence for at least five years and have assets under management of at least $300-500 million. This “screening” de facto eliminates a considerable number of candidates.

Yet several academic studies have demonstrated that a large AUM can have a negative impact on fund performance, as well as on the persistence of that performance. In 2005, a study by Getmansky suggested that beyond a certain AUM level, performance is impacted. In 2008, Boyson demonstrated that “performance persistence is strongest among newer funds”.

It is also a well-known fact that many mutual funds decide to close to new subscriptions above a certain amount. It is not uncommon for hedge funds to return some or all of their capital to investors when the size of the fund becomes too large, as it becomes a drag on performance. Indeed, investment opportunities become more limited as the size of the fund grows.

Sheelah Kolhatkar, a Wall Street columnist and former hedge fund analyst, compared the career trajectory of a fund manager to that of a rock star. She established four distinct stages:

"At the start of a fund's life, managers are over-motivated and humble enough to systematically challenge themselves. This is certainly an opportune time to invest in the fund, but also the riskiest, as funds tend to be sub-optimally sized (which often implies operational...and survival) risk."

"The second stage takes place once the fund has achieved some success and the decision-makers have built up confidence. However, the fund is not yet very well known, the size is not too large, and it is still possible to subscribe."

"Then comes the third stage - which corresponds to a kind of plateau. The fund has become fashionable and attracts the attention of a large number of investors, forcing the fund - in some cases - to refuse new subscriptions".

"The fourth stage corresponds to the decline. The manager is more concerned with life and activities outside the fund's daily routine: buying luxury real estate or yachts, sponsoring a soccer team, etc. At this stage, most funds no longer generate alpha. The manager becomes overconfident, and the size of the fund has become too large to allow any investment agility".

What Kolhatkar has highlighted is a well-known theory which suggests that the optimal time to enter a fund is when AUM is not too large and the number of years of existence is limited.

As mentioned above, the life cycle of a mutual fund can be classified into four stages: emerging, growth, maturity and decline (leading to closure or revitalisation). Each underlying stage has similar characteristics, as shown in the table below.

Being able to identify a manager's or fund's stage of development has important implications for fund selectors, not only in terms of the timing of fund subscription and redemption, but also in terms of expectations of return, volatility, and correlation.

As shown in the graph below, the growth phase and the early years of the maturity stage of a fund represent the optimal time to invest. This is the time window when the fund manager is most likely to consistently generate alpha while economic risk is lower (sustainable profitability, stable operational infrastructure, etc.).

Based on these studies, integrating life cycle analysis into the manager selection process could improve selection efficiency compared to a process based solely on historical performance ("past performance is not indicative of future results").

Performance should be the main factor to consider when selecting collective investment funds. As we have seen, the size and lifespan of a fund do not guarantee future success – quite the opposite. Just like top athletes, most products, or companies, investment funds have their own life cycle. Integrating an additional analysis that identifies the development stage of the fund can improve the manager selection process.