Sometimes managers can be victims of their own success as rapid inflows can be detrimental to the fund’s flexibility than when they have with a smaller pool of capital to work with. 
Many highly-rated managers build up strong track records with funds that have lower assets under management (AUM), but as strong returns are proven over longer periods they attract more capital.
While this may sound like a nice problem to have, it can still present difficulties, particularly for those looking further down the market, with some companies they could have previously invested in now too small and illiquid to buy.
AJ Bell Investments head of fund selection Ryan Hughes said capacity constraints can be a real problem for managers and, ultimately, investors.
“Capacity is an often talked-about issue and sometimes unfortunately a manager can only recognise their capacity constraints after they have reached it, when they see performance begin to tail off,” he said.
Rather than looking at funds that are already huge, we asked analysts which funds at are at a manageable level currently but could be hit by capacity constraints if inflows continue to rise.
As always, past performance is not an indicator of future returns and while the analysts suggest these are funds to keep an eye it is important to note that these are not ‘sell’ recommendations.
Hughes’ (pictured) selection for funds that could face issues of capacity constraints if they receive an influx of inflows is the £2.8bn Liontrust Special Situations.
Already a chunky size, Hughes said it appears that the fund has yet to fall into problems because its performance remains strong.
“While performance continues to be good, the fund size has grown to close to £3bn and with the managers having good stock selection in small cap and AIM stocks, there will become a point when this becomes harder for the managers to effectively implement,” he said.
Indeed, the fund has been a top quartile performer over three, five and 10 years, as the below shows, and more recently has remained an above average performer over one year despite its enlarged size.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
The fund is run by FE Alpha Managers Anthony Cross and Julian Fosh who have been in charge since 2005 and 2008 respectively.
The managers use the ‘Economic Advantage’ process in the fund, meaning it looks for companies with intangible assets that are hard to replicate.
Most important of these assets is intellectual property but it also includes strong distribution channels and significant recurring business.
The fund has a yield of 1.84 per cent and a clean ongoing charges figure (OCF) of 0.87 per cent.
Another fund under pressure with significant inflows is he £320m JOHCM UK Growth, according to Daniel Pereira, investment research analyst at Square Mile Research.
He said: “At £320m, the fund is by no means large compared to many of its peers within its sector.
“[However] the portfolio will be invested across the market capitalisation spectrum and at times will require the ability to have meaningful smaller sized company exposure.”
Although below its peak size in February 2015, the fund, managed by FE Alpha Manager Mark Costar and deputy manager Vishal Bhatia has experienced net inflows this year.
“JO Hambro Capital Management (JOHCM) openly set out what they consider to be the optimal size of assets and will actively turn away new investors when this level is reached,” Pereira noted.
“Without this limit, the fund would be in danger of being restrained by liquidity issues, making it difficult for the managers to implement the investment strategy; namely not having their desired exposure to smaller sized companies.”
The fund has had a particularly strong year, returning 15.2 per cent over 12 months and is in the top quartile of the IA UK All Companies sector.
Over the longer term, the fund is in the second quartile over both five and 10-year periods, though it is above both the sector and benchmark over both periods.
Performance of fund vs sector and benchmark over 10yrs
Source: FE Analytics
The managers aim to identify mispriced or undiscovered growth stocks with a perceived high margin of safety but significant upside potential.
It currently has a large overweight to technology stocks (14 percentage points) while a large underweight to consumer goods companies (14.1 percentage points).
The fund currently has 48.3 per cent invested in FTSE 100 stocks with a 39.9 per cent weighting to FTSE Small caps. It has an OCF of 0.83 per cent.
Old Mutual UK Smaller Companies Focus
Sam Buckingham, investment analyst at Thomas Miller Investment, suggested another fund that could come under pressure is the £272m Old Mutual UK Smaller Companies Focus fund.
Nick Williamson took over as lead manager of the five crown-rated fund at the beginning of 2016 and there are two reasons Buckingham said the fund could become too large – performance and a change in strategy.
Starting with performance, the fund has been the best performing fund in the IA UK Smaller Companies sector since Williamson took charge, as the below shows.
Performance of fund vs sector and benchmark since manager start
Source: FE Analytics
It has returned 77 per cent over the period, more than three times the returns of the Numis Smaller Companies ex IT index.
“Performance has been astonishing, with the fund returning just shy of 80 per cent since the beginning of 2016,” the analyst said.
“This sort of performance naturally breeds interest from investors, and the fund has been seeing inflows as a result.
“Clearly, being a small cap fund, size/capacity is an issue to ensure they have the liquidity required to be nimble enough so as to not hinder performance, and the fund has grown (by a mixture of capital appreciation and inflows) from £150m end of 2015 to its current AUM of £270m.”
As well as its performance, the other reason it is in danger of becoming too large is due to the change of strategy.
This has firstly been to run a microcap strategy within the portfolio that composes circa 10 per cent of the fund, he noted: “To be able to effectively run this microcap strategy, fund size is clearly a key factor.”
“The second change Williamson made was to increase the concentration of the fund – this increased concentration will also contribute to a reduction in nimbleness if the fund continues to grow as it has been.”
The fund, which is made up has 52 holdings, has an OCF of 0.88 per cent.