All good things must come to an end. We all know about the shelf-life of television shows, for example. Funds can also lose their magic. We'd love to say that a good fund will always be good, but funds change. Performance slips, managers leave, strategies evolve. That's why funds need to be monitored.
Here are some of the warning signs to watch out for. These aren't sell signals per se: Instead, think of these as signals that change may be on the way—the fund equivalent of dwindling audiences, sour writing, and producer desperation.
Asset growth
This may seem counterintuitive, but sometimes funds actually need
smaller audiences. As funds attract new investors and grow larger, their
returns often become sluggish, weighed down by too many assets. They
lose their potency and their returns revert to the average for their
group. Some funds stop accepting money from new investors when their
assets grow too large, but many don't. That explains why so many
once-hot funds become mediocre.
There are worse things than being average, of course. But you may still want to keep an eye on your funds as they grow, especially your small-growth funds. Sometimes fund shops will do the monitoring for you, perhaps hiking a fund's minimum-investment amount when strong performance figures lead to a swollen asset base or even closing the fund to new investors if previous steps fail to deter newcomers.
Even shops known for their discipline and their great performance can get caught in this trap. For example, American Century Ultra racked up excellent returns in the 1990s picking small firms with lots of growth potential. The management team was vigilant about selling companies as soon as their share prices increased. Investors flocked to the fund, but returns eventually slowed because the managers just couldn't execute their fast-trading, super-growth strategy with so many assets in tow. So what did they do? They changed their strategy to buying larger companies and trading less often.
American Century's strategy change is a perfect example of the second side effect of asset growth: Fund managers often have to alter their strategies to accommodate new money. Some simply buy more stocks, buy larger companies, or trade less. (When big funds trade frequently, they risk affecting their stocks' share prices as they buy and sell.) No matter what they do, though, they have to make concessions or close the fund. And as a shareholder, you need to be aware of the change and consider whether or not this altered fund fits into your portfolio. Some types of funds are more hurt by asset growth than others.
Manager changes
Most funds are only as good as the people behind them: The fund
managers. Managers decide what to buy, what to sell, and when to make
these changes. Because the fund manager is the person who is most
responsible for a fund's performance, many investors wonder if they
should sell a fund when their manager leaves.
Unfortunately, there is no one right answer to this question. You'll need to consider a few factors. For example, you may have to pay taxes on your sold shares, if they appreciated. And what you give up in taxes may not be offset by future gains in a different fund. You'll also need to consider the record of the new manager—perhaps he or she has already worked on the fund? Perhaps the manager has racked up a solid record at another offering? Keep in mind: A new manager may do just as well as the old.
Further, management turnover won't make much difference when it comes to certain kinds of investing styles. Consider index funds. Managers of index funds are not actively choosing stocks, they're simply mimicking a benchmark. Thus, manager changes at index funds are less important than manager changes at actively managed funds.
Sometimes, it's clear that management turnover is a non-issue. Some fund shops have deep benches, strong analyst training programmes, and extensive research support. These firms have historically had plenty of talented managers and analysts who can take over when a manager departs. Similarly, funds run by teams are often less affected by manager changes. If one team member leaves, there are often two or three other managers who will remain behind.
Of course, changes in management can be a crushing blow to funds run by a single fund manager who has proved to be an adept stock-picker or trader in markets in which there are a wide range of possible returns (such as small growth or emerging markets). Manager changes at good funds from families that aren't strong overall can be bad news, too.
Fund-family growth, mergers, or acquisitions
Why should it matter to your fund's performance if the fund family
decides that it wants to add some new funds to its lineup? Or that it
wants to be sold or become independent? It may not seem like much, but
those things can distract managers from doing their jobs. After all, if
your employer is growing rapidly or is on an acquisition binge, doesn't
that affect how you do your core job? Once-great funds may also stall or
lose their focus when their families expand and launch new offerings.
Keeping watch
How can you find out if your funds are on the verge of change?
First, keep tabs on your fund families using the public information available. Regularly visit their websites and look for news of growth plans, mergers, and new fund launches. And always scan their marketing materials that jam your mailbox.
Next, turn your attention to third-party sources, including Morningstar, and learn what these groups have to say about your funds and your fund families. Firms such as Morningstar aren't in the business of selling their own funds and they take their roles as industry watchdogs seriously. Check out our fund news, read our fund analyses, and see what our analysts are saying about fund management in our reports. Make sure to read what members of the financial media are saying, too.
Finally, check up on your funds each month to make sure that things are status quo. Have their assets grown rapidly? Are their managers still in place? Is there anything notable going on with the fund family?
If you find that changes may be afoot, ask questions. If you find that your fund family is launching a new fund that sounds a lot like the fund you already own, for example, ask how the funds will differ and if this will mean more work for your fund manager. Or if you're worried about asset size, find out if the family plans to close the fund any time soon.
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