Level 3 – Equity Chapter 25 – Implicit costs and relation with AUM

Can somebody explain the relation between small/large stock companies, position size, AUM in relation to Implicit costs? (Ref Page 512 of curriculum and ques 3 of EOC question for chapter 25)

For instance why implicit costs is not high for small stock companies with large no of securities and small fund size but the implicit costs are high for small stock companies with small no of securities with large AUM?

Small cargo ship going through Suez canal

EverGiven going through Suez Canal

Thanks @fino_abama.

I assume the ship size is akin to AUM/Fund size and the canal is akin to small stock companies? But how does the number of securities matter in this regard?

Secondly, how would this apply to large cap companies?

Yes, the ship size is akin to AUM and the width of the canal is akin to the number of securities of the small stock companies.

If the fund size is too large and number of securities of small cap stocks is small, there would not be enough small stock companies to deploy all the funds. This will result in market impact (i.e. high implicit cost)

For large cap companies, there will be sufficient depth and liquidity to absorb the AUM/fund size, so minimal to no market impact

Thank you so much @fino_abama for your support and that’s a great analogy to remember :slight_smile:
Now everything makes sense :+1:

1 Like