People often remark that “AUM is the enemy of performance.” But is this truly always the case? Here’s another thought-provoking excerpt from Stephen Duneier of Bija Capital Management that explores the nuances of the AUM-Performance relationship.

AUM, Expected Return, Sizing, Selectivity, Liquidity

“Since becoming a portfolio manager more than ten years ago, I have managed as little as $8 million and as much as $910 million. What did I do differently at each extreme? Nothing. On average, I had the same number of trades in the portfolio, structured the positions the same, analyzed the markets the same, generated trade write-ups the same, and in proportion to the overall portfolio, I sized the positions the same. Those are the relevant factors that investors should be asking about when it comes to AuM and here is why. With a minimal amount in AuM, you are clearly not confronted with capacity constraints, therefore you can be highly selective when choosing among opportunities, allowing for optimal portfolio composition. While operating below your capacity constraint, the portfolio composition runs within a fairly steady range. So how do you identify the limits of a PM’s capacity? 

Well there are two determinants of capacity. One is internal (mental) and the other is external (market). For those trained as prop traders and PMs within large organizations, you are typically allocated risk rather than capital, which means you think of gains and losses in notional terms. That makes for a difficult adjustment to the world of proportional returns, and particularly shifts in AuM, thereby prematurely capping either AuM growth, or the risk and returns on it. The external constraint is market liquidity per trade or structure. So long as I can maintain the same proportional exposure to a given position, I remain under my capacity limit. Once I have to increase the number of trades in order to maintain the same overall proportional risk exposure, I have breached max capacity for my style. You see, before you reach capacity, you are selecting only the best ideas and expressing them via the optimal structures. You could do more, but you choose not to. When your overall risk budget gets to a point where you cannot maintain the same overall exposure with the same number of trades, you must begin adding less optimal structures and even ideas of lesser conviction. That is the true signal of having breached your maximum capacity.”