Funds Fight the Flab

Swelling assets can weigh on a fund's performance. Be aware of signs of bloat.
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Friday's Fidelity fund closings mark another victory for shareholders in the battle of the bloat. But will it be enough to win the war against oversized funds?

As of Friday, new investors seeking entrance into the $30 billion

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Fidelity Growth Company, $12 billion

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Fidelity Mid-Cap Stock, $6 billion

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Fidelity Advisor New Insights and $65 billion flagship

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Fidelity Contrafund funds will be forced to look elsewhere. The Boston-based fund giant, facing continued pressure from current shareholders, newsletters and fund analysts like

Morningstar

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, shut the doors on these funds because the generally accepted principle is that too much money eventually weighs on a manager's ability to find new stock ideas and put overflow cash to work.

Well, the doors won't completely close. All four funds will still accept investments from current shareholders, as well as money from new investors via retirement plans that already offer the funds as an investment choice. In other words, these funds could still grow fatter.

On the other hand, the $1.9 billion

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Oppenheimer Real Asset fund, which invests in commodity futures, also will close to new investors Friday. But it's a hard close, which means that even current shareholders won't be able to invest additional sums, except for reinvesting dividends and distributions.

No matter if the close is hard or soft, the shareholder-friendly moves arrive at a time when new highs are being created across asset classes and inflows are gaining steam. As the old industry saying goes, flows follow performance and the result is a supersizing of funds, which means that more fund families will be forced to deal with the question: to close or not to close.

As for investors, they need to decide sooner rather than later as to whether or not their fund has grown too large for their own good.

"There is big tension when a fund company decides to close a fund, because growing assets is how they make their money," says Roy Weitz, mutual fund consultant and publisher of FundAlarm.com. "Meanwhile, investors will push for an early close because by the time a fund closes it's usually already too late."

How Bad Is the Bloat?

According to Morningstar, from the end of 2000 to mid-February, the number of $1 billion-plus funds has grown from 730 to more than 1,150. Among funds focused on small-caps -- which are most seriously affected by bloat since the stocks in the portfolios are less liquid -- the figure has grown from 36 to more than 80. And 35 of those $1 billion-plus funds are closed to new investors.

"It's no secret that it's hard to find a good small-cap fund, foreign or domestic, that is still open and not too bloated from assets," says Morningstar director of fund research Russel Kinnel.

Kinnel says he studied fund closings not too long ago and found the median point at which funds close to new investors is $800 million for small-cap funds, $3 billion for mid-caps, and $18 billion for large-caps.

Using those levels for guidance, Kinnel put together a list of factors investors should consider before deciding whether their fund has gained too much weight.

  • Check out the fund's turnover. "A fast trading strategy requires a tight lid on assets because it places a tremendous premium on liquidity, so a high-turnover fund with assets over those midpoint closing levels would be a worry," Kinnel says.
  • Look at the depth of the fund's bench. One way fund families avoid closing funds is by adding analysts to their research teams. That way an overburdened fund manager will have more eyes and ears on the Street to find new ideas.
  • That said, mutual fund consultant Geoff Bobroff cautions that while adding new analysts may increase the mix of ideas and infuse some dynamism into a fund grown stodgy, "adding more coaches does not deal with the fact that the same players are on the field." So even if new blood is added to a fund's stockpicking team, there are still only a finite number of stocks to put that huge cash balance to work.
  • Find out much money your fund's manager is running for people other than you. Most fund managers run more than one fund, or they run separate accounts on the side, which means that their best ideas -- and their time -- are not yours and yours alone, Kinnel notes.
  • Two of the Fidelity funds that closed last week, Contrafund and New Insights, were managed by Will Danoff, and there is overlap among the stocks in the two funds. So while Danoff may not be playing favorites between the two funds, many fund investors may prefer it if his time and loyalties were not divided. On that note...
  • See how much money the firm runs in similar strategies. "At some fund companies you have a lot of analysts who are shared firmwide, so you may have a lot of fund managers trying to squeeze through the same door at the same time," Kinnel says.

Of course, even with all these items to look out for, it's tremendously difficult to spot the bloat-induced style drift or poor performance until it's too late. Furthermore, it's worth noting that asset bloat may not even be the grave problem people think it is.

In a 2003 study, Morningstar rival Lipper couldn't link fund size to poor performance.

"It is debatable whether fund size truly matters," says Andrew Clark, senior research analyst at Lipper. "Returns may go down not due to asset bloat, but to sector rotation."

Fund guru Weitz is a believer in the bloat.

"It's a real phenomenon, and if you need proof, just get a money manager to speak off the record as to whether its harder to manage way too much money."