AUM (Asset Under Management) is the total market value of the securities a mutual fund manages on behalf of investors. AUM is calculated by adding mutual fund holdings, bank deposits, and cash. Many mutual funds keep up to 20% of the fund in cash without investing in any securities, this is known as cash drag. This is used while investors redeem their funds.
Any fund holding higher AUM is an indicator for investors to choose them, as it denotes the strength of the AMC. In addition, AUM stands as one of the parameters for calculating the fund’s expense ratio (annual operating fee).
When AUM holds a high market value of securities, the expense ratio will be low. Similarly, when the AUM is low, the expense ratio will be increased.
Why is AUM a crucial factor in choosing a mutual fund?
Many mutual fund companies try to hold their securities (stocks, bonds) for a more extended period. As a result, these companies hold up to 20% of actual AUM (only market value of securities) as cash. This cash is used to deposit in investors’ accounts while they redeem.
In every mutual fund, the maximum shares are invested by Foreign institutions, domestic institutions, corporate companies, Government. As a result, retail investors have few holdings as a whole.
Let us consider a case where the stock market crashes down. This will spread the selling panic all over the market.
So, the foreign and domestic investors could redeem the holding to save their investment. But, in this scenario, 20% of cash liquid can’t fully the redemption value. So, Mutual funds companies are forced to sell their securities in the secondary market (in most cases low price). This could make a significant impact on the retail investor.
AUM with less than 1000 crores can result in a negative return in a short period. That’s the reason you should choose mutual funds holding AUM higher than 1000 crores