Morningstar Magazine - February/March 2014 - (Page 49)

Small Fidelity Magellan FMAGX and Fidelity Contrafund FCNTX suffered from asset bloat. However, Magellan got much larger, and its managers post-Peter Lynch were less able to adapt than Will Danoff has been at Contrafund. Contrafund was closed for a while, but Danoff has kept doing a remarkable job even as his total assets have grown above $100 billion. Morningstar pays attention to asset bloat even with the knowledge that the Danoffs and Joel Tillinghasts (Fidelity Low- Priced Stock FLPSX) of the world may be able to overcome it. Even they, though, would likely have had even better performance with smaller asset bases. Micro Pulling Your Coat to Bloat Exhibit 1 Franklin Balance Sheet's Move up the Style Box Mid Large Giant December 31, 1999 to December 31, 2003 Deep Value Core Value Core Core Growth High Growth Source: Morningstar Direct A less common, yet still irksome asset-bloat problem is hot money. When Fairholme FAIRX surged to $19 billion from $6 billion in just two years, manager Bruce Berkowitz argued the added heft enabled him to get a seat at the table and do bigger deals than he could do before. However, what he hadn't bargained for was just how quickly those assets could leave. When a fund has amazing returns and stays open, it can get some very hot money. Hot money chases the very best performers and thus is prone to leave at the first downturn. When everyone runs for the door, it can cause headaches. That's what happened when Fairholme had a terrible 2011. Heavy redemptions meant Berkowitz had to sell stocks he didn't want to, and it dropped the fund's cash position lower than he wanted it. These things in turn made performance worse. A chastened Berkowitz later closed the fund in the hopes of keeping hot money out. It's a good reminder that, in an open-end fund, it matters who your fellow shareholders are. Asset bloat is sneaky because it is rare that it is the main driver of a fund's single-year performance. Asset bloat can be a handicap, but a bad year doesn't prove its existence. Both So, how do you know if a fund is getting too big? I looked at the median asset bases at which funds closed. You can use them to compare with your funds. If it's a fund with low turnover, you could give it a little more slack; if it has high turnover, you might want a fund with assets below that median closing level. I find it most useful for funds where one or all managers operate together as opposed to running separate sleeves. (One note: Morningstar records the most recent closing or reopening date, but we don't maintain the full history, so I don't have all closings.) I've run this median closing data past some trading cost consultants, and they told me it was pretty close to the levels where they recommend closing. For U.S. small caps, the median closing level is $723 million, and for foreign small caps, it was a nearly identical $730 million. The smallest closing level was $15 million for Birmiwal Oasis BIRMX, and largest was AllianzGI NFJ Small-Cap Value PSVIX, which closed at $5.9 billion. Surveying the Morningstar 500 funds, I see that many funds above that median closing level are closed, multimanager, or passively managed. However, T. Rowe Price New Horizons PRNHX is not. With $14 billion in assets, it's worth keeping an eye on. The plus side is that the fund isn't getting a lot of inflows this year, and T. Rowe Price has both a good record of closing funds and of funds performing well after closing. Asset size is part of why the fund received a Morningstar Analyst Rating of Bronze rather than Silver or Gold. For mid-caps, the median is $2.9 billion as set by Artisan Mid Cap ARTMX. Schroder U.S. Small & Mid Cap Opportunity SMDVX closed at $275 million, while T. Rowe Price Mid-Cap Growth RPMGX closed at $16.7 billion. Most of the really big mid-cap funds are in redemptions, so the markets are fixing some of the problems. Fidelity Low-Priced Stock is a massive $44 billion. Tillinghast has proved his mettle, but when he retires it's time to start worrying. The first fund I found with one-year flows above $1 billion was American Century MidCap Value ACLAX, which has $4.7 billion in assets. In fact, the fund has brought down turnover as assets have grown. However, the number of holdings and market-cap exposure have not changed. Performance has slumped lately, but as I said before, I'd be cautious about assuming cause and effect there. I'd say the fund is starting to send some warning signs, but it's early days. It merits a close watch, but I'm not worried yet. Janus Twenty JAVLX closed at $9 billion and Sequoia SEQUX partially closed at $4.9 billion. The diversified Vanguard Primecap VPMCX and Vanguard Primecap Core VPCCX closed on the same day in 2009 at around $26 billion and $3.8 billion, respectively. The two have a ton of overlap, so really it's more like a closing at $30 billion. Among focused large-cap funds in the Morningstar 500, Fairholme and Longleaf Partners LLPFX are on an asset diet, as each has had more than $1 billion in outflows the past year, so no worries there. Yacktman YACKX and Yacktman Focus YAFFX have both seen inflows of more than $2 billion in the past year, and both are north of $10 billion. The good news is that they are comfortable holding cash. Still, it's something to watch. K Russel Kinnel is Morningstar's direct of mutual fund research. global.morningstar.com/Morningstarmagazine 49 http://global.morningstar.com/Morningstarmagazine

Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2014

Morningstar Magazine - February/March 2014
Contents
Contributors
Letter From the Editor
Preparing for the Next 50 Years
Morningstar Managers of the Year
Fixing the Trust Deficit
Rethinking the Path to Retirement
Trends
Same Old, Same Old
Global Briefs
The Economic Implications of an Older World
Banking on Performance
Is the Affordable Care Act Healing Health Care’s Woes?70
Baxter Has a Positive Prognosis
Leading Fidelity’s Charge for RIAs
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Moving the Goal Post

Morningstar Magazine - February/March 2014