<Bt-5z54>Success can bring serious problems for fund managers
"The worst effect of the asset bloat phenomenon is simple," Morningstar says. "The more money a fund has in it, the less nimble it becomes. If a fund's asset base increases too much, its character necessarily changes."
Some fast-growing funds close to new investors to try to mitigate this effect. Others resist any such move, insisting they can handle the extra load.
Closings don't always solve the problem anyway, especially if a fund leaves its doors open to additional investments by retirement-plan members or to all clients of brokers and advisers who have existing accounts. The damage may not be immediately visible to the casual onlooker.
At its devilish worst, asset bloat can give everyone an exaggerated view of how much money a fund is actually making for its investors as a group.
"A successful fund attracts massive amounts of money and then, later, performance gets very mediocre," said Charlie Munger, vice chairman of Berkshire Hathaway Inc., during a question-and-answer session at Berkshire's annual meeting early this month. "Then they keep publishing their results for the whole period. If you made the same computation per dollar, controlled per year, you'd have a much lower rate of return for these people."
What to do, as a fund investor, to protect yourself? Fortunately, vast amounts of information are published regularly about funds, and anyone can monitor them closely for changing performance patterns.
Look at the biggest of all funds, Capital Group Cos.' $166 billion Growth Fund of America, whose assets have more than quadrupled in the past five years, from $36 billion in 2002. The fund has achieved that dazzling growth with some impressive long-term results, including a return over the past five years through the end of last week of 11.6 percent a year, according to my Bloomberg.
To check for the effects of asset growth, we can simply compare that five-year number against the three-year return, which is 14.7 percent annualised; the one-year return, which is 11.3 percent, and the return for 2007 to date, which is 7 percent. While the most recent numbers aren't as good as the five-year results, the three-year figure is better. Simple return numbers like these are subject to the ups and downs of the stock market generally. To control for this, we can check instead the amounts by which the fund beat or trailed a market benchmark, such as the Standard & Poor's 500 Index.
Bloomberg data show the Growth Fund of America outperformed the S&P 500 by 2.2 percentage points a year in the past five years, and by 1.5 points in the past three years. In the past year, it lagged the index by 6.2 percentage points.
Aha! An investor may read this as a tentative signal, at least, that the fund is feeling the weight of its burgeoning assets. Fund performance is always a moving target, and the Growth Fund is back beating the S&P 500, by 0.15 percentage point, for 2007 to date. Still, the fund clearly merits a place on the asset-bloat watch list.
The problems posed by asset growth are often cited as a reason to shun actively managed funds in favour of index funds, which keep the same shape (that of the index on which they are based) as they grow. Well, index funds aren't immune to the effects of shifts in market conditions.
Funds based on the S&P 500 attracted huge asset flows in the late 1990s. Wouldn't you know, the S&P 500 then embarked on a sustained period of sluggish performance as the big stocks that dominate the index lagged behind small stocks.
The lesson to be learned here seems broader than a simple question of index funds versus active funds. In the money- management game, anything that enjoys a surge of popularity bears especially close attention afterward.
(Chet Currier is a Bloomberg News columnist. The opinions expressed are his own.)
