Big Mother Mutual Funds
The Real Returns posted an interesting list of the 20 largest mutual funds, and I thought it was interesting, so let me just mention some things about mutual funds.
A larger mutual fund is typically an indication that the fund is perceived as more desirable, and as a result investors put more and more money into the fund. However, this trend can produce some undesirable side effects. For one, larger funds are not as agile. Alerts setup on the floor notify traders if unusually high sales are occuring on an individual security. Sales largely or consistently in excess of this limit can cause rapid sell offs that result in lower prices. Fund managers desperately want to avoid this if they have positions in a security of 10s of millions of dollars. As a result a large fund could take weeks to sell of their entire position, resulting in sub-optimal selling prices.
Additionally, when a fund becomes too large, they can end up losing the edge that made them so popular in the first place. Because many fund managers are paid based on total assets managed, as funds become larger they become less aggressive in order to avoid rocking the boat. Most of the Real Returns list are returning under 7% for the last 5 years, with only 4 breaking 10%.
In its December 2005 issue, SmartMoney demonstrated some examples of large funds that are underperfoming and smaller funds offered by the same firm that can produce better results. One example was the Putnam Growth & Income fund (PGRWX), which holds $16.3 billion in assets and had a paltry 5-yr average return of 2.8%. By contrast the Putnam New Value fund (PANVX) has only $1.9 billion in assets and performed with a more solid 5-yr average return of 8.2%.
When shopping for a new fund, it isn’t necessarily advantageous to buy the biggest or most popular. Look at companies with solid track records of performance, and find funds managed by those firms that are growing but not excessively large. Those may well turn out to be the smartest money around.
5 Comments Add your ownSubscribe
1. Jason | December 9th, 2005 at 3:01 pm
It’s also bad to invest in large popular mutual funds during a secular bear market.
But things really ARE different this time. The singularity is near!
Nice post, Chris. Useful information to think about when, say, choosing a mutual fund for your 401k. No matter the direction of the market, smaller mutual funds will always be more flexible (and thus make more money) than larger ones.
2. Small-caps to the Rescue &hellip | December 16th, 2005 at 9:45 am
[…] Last Thursday, Chris wrote about Big Mother Mutual Funds and pointed out some reasons why you might not want to buy the “biggest and best” when it comes to mutual funds. Another problem with large mutual funds is that they lose their flexibility to invest in small-cap stocks. These funds are making investments in the tens of millions, which could add up to a sizable percentage of a small-cap’s total shares. It’s hard for a larger investor to make (or pull out of) an investment worth 5% or more of a company. […]
3. Intro to 401k Part 2 on I&hellip | January 30th, 2006 at 9:01 am
[…] Be wary of jumping on the band wagon of “hot funds”. Often, if a fund has a good year, a bunch of new money will roll in. There is no reason to think that the fund will be as good at running 50 billion dollars as it was at running 5 billion. In a past article, Chris discussed the challenges big funds face. […]
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[…] The Choosing a Fund section of Part 2 of our introduction to 401(k)s is now ready. Enjoy. […]
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