It would seem that too many assets pose the biggest threat to small-company funds. But asset size is not a problem for all small-company funds. Instead, asset overload is especially detrimental to small-cap funds that trade a lot.
When most people think of trading costs, they think only of brokerage commissions-less trading, lower costs. But there is a second component of trading costs: the cost of "moving the market." This is a component that is directly affected by asset size. Funds can "move" the market when they are unable to buy stocks without pushing the share price of that company upward as they're buying; likewise, funds that are "market movers" cannot sell stocks without pushing the price downward as they're selling.
Think of the stock market as a giant auction house. In an auction, the price of an object goes up as more people bid for it. As more people enter the bidding, the price rises, making the object more expensive for the eventual purchaser. Now think of each dollar in a mutual fund as another bidder. The larger the fund, the more likely it will be to boost a firm's share price simply by "bidding" on its shares. And the more frequently a larger fund trades, the more likely it is to rack up high trading costs, often called "market impact costs."
Growth and value funds are both affected by this phenomenon, but fast-trading growth funds usually suffer more. That's because growth managers are usually competing with plenty of other buyers for popular merchandise-high-priced, high-growth stocks. They're like the people who go to auctions and bid on Jackie Onassis' jewelry. Value managers, on the other hand, are like shoppers combing through yard sales every weekend. Because there's a lot less competition for a beaten-up lawn chair with hidden potential than for Jackie's string of pearls, prices don't get "moved" nearly as much.
How Funds Can Manage Asset Growth >>