Publish date:

Clone Funds: Is Two a Crowd?

The Janus 2 fund illustrates the potential risks and rewards of duplication.

Cloning a mutual fund isn't all that different from cloning Dolly the sheep: The great promises coupled with the potentially dire consequences make it a double-edged sword.

Janus'

decision earlier this week to close its $50 billion flagship

(JANSX)

Janus Fund to new investors and open up a similar fund,

Janus 2

, marks the latest example of a fund firm rolling out a sequel to a popular offering.

Whether a firm is offering a clone fund because it's closing the original or simply because it wants to increase its offerings, the aims are the same: to improve performance at the original and give investors a new avenue for their cash. Sometimes this works as planned, but there are a variety of pitfalls, such as too much stock overlap, which can weigh down the old fund, or styles so dissimilar between the two that the new fund is a clone in name but not performance. These matters should give investors pause before they break out their checkbooks.

A clone fund arises when a fund company decides to create a new fund with the same name and often an investment philosophy and strategy very similar to an existing fund. Companies usually open up a clone fund when they close one of their more popular funds that's gotten too large to effectively administer, as in the case of the Janus Fund.

Firms also may form a clone fund while keeping the original fund open to new investors to increase their product offerings, such as

Fidelity

did when it launched its

(FEQTX) - Get Report

Equity-Income II fund in 1990 as an adjunct to its

(FEQIX) - Get Report

Equity-Income fund.

While they usually share a name, clone funds may have a slightly different investment strategy from their precursors. One example is the $1.7 billion

(FCONX) - Get Report

TheStreet Recommends

Fidelity Contrafund II, which is focused more on large-cap stocks in growth sectors such as tech than its predecessor, the $45 billion

(FCNTX) - Get Report

Fidelity Contrafund, which

Morningstar

defines as a large-cap blend fund.

Whether or not clone funds are a good idea for investors depends on many factors, most important of which are size, investment style and management of the new fund, says Morningstar's director of fund analysis Russ Kinnel.

Just because the clone fund has the same name and strategy as a hugely successful fund doesn't guarantee that investors will get the same returns, warns Andy Keeler, a certified financial planner based in Columbus, Ohio. Often, the share prices of stocks in the original fund have gotten so high that the clone fund can't buy the same shares, so the clone's fund manager must look for other investments to achieve comparable performance, says Keeler.

A case in point is the $4.6 billion

(NICSX) - Get Report

Nicholas fund, which has outperformed its $793 million

(NCTWX) - Get Report

Nicholas II clone. Nicholas has posted a 13.08% one-year annualized return, a 9.76% three-year annualized return and a 16.95% five-year annualized return compared with Nicholas II, which has had gains of 11.46%, 6.57% and 14.09%, respectively, for the same periods. Though Nicholas' investments are more concentrated in large-cap stocks and Nicholas II is focused heavily on medium-sized growth companies, 10 of the funds' top 25 holdings were the same as of July 31.

Started in 1969, the Nicholas fund was heavily invested in small-cap stocks. But as the fund got too large to maneuver among smaller-cap companies, the company decided to launch the Nicholas II fund in 1983. Both funds are still open today, with the Nicholas fund focusing on large-cap stocks and the Nicholas II fund investing more in mid-cap shares.

So if a clone fund is different from its original, why give it the same name? That's usually done for marketing purposes, say analysts. A fund company might want to capitalize on the popularity of the original fund by giving another fund the same name.

As for the investors in the original funds, Kinnel says they could be at a disadvantage if a very similar clone opens up.

"It certainly reduces the value of closing the original fund in the first place because you may well get overlap in that trading," he says. "If the same manager is managing the fund, that takes some of their time from managing the original fund."

If both funds end up buying the same stocks, the share prices of those stocks could run higher if both funds are trying to buy, or lower if they're attempting to sell, says Kinnel. In addition, investors in the closed fund don't get the tax benefit that comes from having more assets and shareholders invested in the fund.

Closing a fund does have its advantages, however, especially when it is getting too big for the manager to move in and out of stocks quickly.

"I think it's a good thing," says Keeler. "I think Janus' announcement to close the fund is done in an effort to improve performance for current shareholders and let future shareholders get in on the ground floor of a new fund."