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As investors, we typically want to earn above-average returns. That, perhaps, explains why most of us invest in active funds — funds mandated to beat the benchmark index (generate alpha). But choosing an active fund is not the same as choosing a consumer product.
We cannot simply choose a fund with large assets under management (AUM), believing that more individuals choosing a fund or more money flowing into a fund is good. Here, we discuss how you should consider the growth in AUM at a unit level as the first step in choosing an active fund.
AUM growth
A fund’s AUM can increase for two reasons. The fund’s portfolio may have accumulated gains. The fund manager could have sold stocks at higher prices and realised the gains. In addition, the fund could carry gains that are yet to be realised. Increase in AUM because of gains bodes well for the unit holders. Then, there is a fresh inflow of capital from existing unit holders and new investors.
This may not always be good for unit holders. Why?
Typically, a fund manager will have a rule (referred to as an alpha strategy) to pick stocks from the fund’s investable universe. Best practice indicates the investable universe ought to be a fund’s benchmark index. In India, a large-cap fund’s investable universe can extend beyond large-cap stocks. SEBI definition states that large-cap funds must invest not less than 80% in large-cap stocks. This allows such funds to invest not more than 20% in, say, mid-caps.
A crucial characteristic of an alpha strategy is that it is not always scalable. That means a strategy that works well on, say, an AUM of ₹10,000 crore may not necessarily work when the AUM increases to ₹25,000 crore.
Conclusion
It is difficult to determine how much of the growth in AUM can be attributable to gains and how much of it to the fresh inflow of capital. So, it is best to evaluate the growth in NAV over multiple periods. Why?
Fresh capital into the fund will increase the numerator in the form of cash and the denominator in the form of units in the NAV calculation. Note that NAV is the market value of the fund’s portfolio (including fresh inflows) divided by the number of units.
A fund that shows a significant increase in NAV growth compared with its stated benchmark is a fund that you must further analyse for potential investment.
(The author offers training programmes for individuals to manage their personal investments)
Published – August 18, 2025 05:55 am IST
