You may have done your homework and found a great mutual fund to invest in, only to realize that it has been closed to new investors. This happened recently to me. In my employers sponsored 401K plan, Fidelity Low Price Stock (FLPSX) is technically one of the funds that I can select. However, when I attempted to re-allocate some of my funds into it, I was unable to choose it because it was closed to new investors. Why would a fund ever decide it doesn’t want new investors? Let’s discuss.
The Mutual Fund Bohemoths – How’d they get so Big?
When mutual funds historically perform well, they become cash magnets and their total assets tend to grow to extraordinary levels. This happens for two reasons:
- Investors re-invest their capital gains and dividends (which are bloated due to strong performance) into the funds.
- Performance chasing investors add new assets to the funds.
Some of the bohemoths include names like Fidelity Magellan, Fidelity Contrafund, Fidelity Low Price Stock, Dodge and Cox Stock Fund – all managing tens of billions of dollars in assets (interestingly some of these funds have now re-opened their doors, we’ll discuss this later on in this post).
Dam the Floodgates
So what does the fund company do? It slams the door on new investors. There is a fear on behalf of the fund companies that many investors will leave a fund if they see its assets getting to large. It’s kind of an interesting paradox in a way. Mutual funds will market and advertise to get more funds so that they can grow (and make more money off of management fees), but when they get too large, they shut down.
There comes a tipping point in the life of a mutual fund when they get so large that they become slow and sluggish. They no longer are able to jump in and out of stocks without making a noticeable stir in the market. Their ninja-like qualities of stealth and quickness disappear. In order to prevent this mass exodus, funds will not allow new investors to join. They shut their doors.
The 5% Rule and Sluggish Performance
According to the Investment Company Act of 1940, diversified mutual funds are only allowed to buy into positions of companies that equal at most 5% of the value of the fund (you will notice that in holding disclosures that some stocks may be over 5% of a funds holdings, but this is due to capital gains, not buying a larger position). This law, combined with bloated assets in a fund usually results in the fund being forced to buy into more and more companies. When a fund starts buying more and more companies, it starts to resemble its index or the general market. It becomes increasingly harder for that fund to outperform. It loses its competitive edge.
What is a Closed End Fund, is this the Same thing?
In an upcoming post, we’ll take a closer look at closed end funds. For now, I’ll give you the short answer – no, they are not the same. Closed end funds trade like a stock on the open market, have a set number of shares, and can trade at a premium or discount to their net asset value, whereas the types of funds we have been discussing are open-ended funds, which are bought and sold at their net asset value.
What does this Mean for you?
1. Pay attention to what funds are doing. In a bull market, you might see a lot of funds close to new investors. In a bear market (as we are in right now), you might see many funds re-open to new investors. In fact, Fidelity Magellan and Dodge and Cox Stock have both recently done this.
2. Find copycat funds. A common practice you will see is the fund company will ask the manager of the extremely popular fund to begin a completely new fund, so that they can attract new investors by starting off from scratch with zero assets and the exact same investing strategies. These new funds are usually good opportunities, you basically get the same great manager with the flexibility to invest in whatever he/she wants without being bogged down with too much money to manage.
3. Don’t wait for your desired fund to re-open. Sometimes funds will wait years to re-open, if they do at all. With over 6,000 mutual funds to choose from, don’t hold your breath, you have more than enough open funds to choose from.
Are there any mutual funds that you’ve wanted to buy into that you haven’t been able to? After reading this post, would you still buy into them if they re-opened?
I saw a few funds listed in my 401k that were closed to new investors. Seemed odd at the time such a fund would be listed. Thanks for pointing out the pros/cons of these options.
Michael – Yeah, if you look at the performance of some mutual funds, it’s surprising to see them closed. The #1 reason why a fund would close is due to its overall asset amount being very high.
So far I’m up 88 % this years. Who needs mutual funds?
Occasionally I look to see if OTCFX from T Rowe Price is open to new investors. Small cap fund that’s beaten the market (on average) since Eisenhower was in the White House.