Is Your Fund Too Big? Fund managers can falter when they have too much money on their hands. Here's how to spot trouble
(MONEY Magazine) – Your fund may be carrying some extra weight these days. With the return of the bull market, investors have put more than $450 billion into mutual funds since 2002. Many managers who only recently ran millions of dollars are suddenly investing billions. That can create problems. Among them:
-- Big funds don't trade as nimbly as little ones. It's a lot easier to buy or sell 250,000 shares of a stock at a good price than it is to buy or sell 5 million. -- Oversize funds can't invest as heavily in small-cap stocks or other less liquid securities. But sometimes those are the investments that produce the biggest returns. -- The more money a manager has to put to work, the harder it is for him to concentrate assets on his best ideas.
So how big is too big? There's no magic number. One fund may stumble at $500 million while another keeps shooting out the lights with $20 billion. The American Funds family has posted impressive numbers despite managing some of the biggest funds in the country. But here are some warning signs that your fund may be getting too rich for its own good.
1. Its cash stake is up
Since 2002, assets in the First Eagle Overseas fund have nearly quadrupled to $6 billion. The fast pace of inflows combined with the rally in foreign stocks made it tough for managers Jean-Marie Eveillard and Charles de Vaulx to find enough investment opportunities. Instead, they let a lot of that money just sit in cash--as much as 26% of the fund's assets in February. That made the fund less risky, but it also lowered its potential return. Fortunately, Eveillard and de Vaulx did the right thing: They closed the fund to new investors in January. The fund's cash stake has since receded to 20%.
2. Its average market cap is creeping higher
If you own a small-cap or midcap fund, a higher average market cap may indicate that your manager is resorting to bigger stocks to stay fully invested or liquid. You can look up this number easily at Morningstar.com; the site will even show you how the fund's style has changed over the past three years. (On the fund report, click the Portfolio tab.) A caveat: Some managers switch among large- and small-cap stocks, depending on where they think the best picks are. So a style change doesn't always mean that a fund is getting too big--but it can be an awfully good clue.
Consider the case of American Century Ultra. The fund racked up big gains in the late 1980s and early 1990s by buying small, fast-growing companies and trading them quickly. But as assets soared--more than 1,200% from the beginning of 1991 to the end of 1992--the fund's market cap began rising. It turned into a midcap fund for a while. And these days it's a large-cap growth fund with a market-lagging long-term record.
3. It's spreading out its bets
If your fund held 50 stocks and now owns 75, that's a red flag. What's the problem with a fund buying more stocks than it used to? Nothing, if your manager is actually finding that many great new investments. But some of the best managers we know tell us they run out of inspiration after 50 or so picks. The danger is that cash inflows have forced your fund to buy second-string stocks.
Adding too many new names isn't the only way that managers can end up watering down their funds. They can also concentrate less of the fund's money on their favorite picks. Look at the percentage of your fund's assets that go into the five or 10 largest holdings. If that number is declining, you may get less impressive returns in the future.
4. It's starting to look an awful lot like the S&P 500
This is the final stage of the too-much-money syndrome. The fabled Fidelity Magellan has become the classic case. The $67 billion fund--until 2003 the largest actively managed equity fund in the country--has an average market cap of $60 billion, higher than that of the S&P 500-stock index. It holds more than 200 stocks, and its top holdings mirror the biggest names in the S&P: Wal-Mart Stores, General Electric and ExxonMobil. (A Fidelity spokesman points out that there are some differences: Notably, Magellan has 25% of assets in non-S&P names, and its sector weightings often differ from the index's.) You're not likely to go wrong with such a fund. But then again, it's unlikely to beat the market by much--it pretty much is the market. The problem is that Fidelity Magellan charges 0.72% in expenses. If you are satisfied with marketlike returns, why not buy the Vanguard 500 index fund instead, for just 0.18%? --ADRIENNE CARTER