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Should You Bite on These Recently Reopened Funds?

They're not all contrarian plays.

Christine Benz, 10/02/2007

Rushing the doors of a fund that's about to close is usually a sucker's bet. That's because funds usually close when their managers are finding little to buy--not exactly a sign of a fertile investment climate.

So, what about the opposite? If a once-closed fund reopens, is it a good time to buy in? It often is, but not necessarily. Most managers will tell you that having to meet redemptions without an equal or greater flow of new money--which managers of closed funds often do--can complicate the investment process because it forces them to liquidate positions they'd rather hang on to and it reduces the cash available for new investment ideas. In those cases, reopening can be an indication that a manager is finding a lot to buy, but it's also reflective of the fact that, given their druthers, managers would rather keep their assets stable or increasing rather than go into redemption mode.

In a similar vein, funds may reopen because institutional clients are reducing their stakes (often because of rebalancing), thereby freeing up overall capacity in that investment strategy. That scenario has been playing out recently in the small-cap space: As institutional clients have rebalanced, several funds have flung open their doors for new retail business. The managers are trying to keep their assets relatively stable, but it's possible that institutional investors--by scaling back on an asset class that has outperformed for the better part of the decade--represent the smart money in this instance.

With a healthy skepticism in mind, we took a look at a crop of funds that have reopened in the past several months. A small handful are worth a second look, but it's hard to get too excited about most of them, mainly because they operate in asset classes that aren't particularly compelling right now.

Diamond Hill Small Cap DHSCX
This little-known fund is a great example of an offering that has reopened because management doesn't want to sell its holdings simply to raise money to pay departing shareholders. Diamond Hill is an extremely shareholder-friendly firm that has closed funds proactively in the past. The firm earns top stewardship marks, so we're inclined to give it the benefit of the doubt when it comes to the reopening. It's also worth noting that some of the fund's holdings have recently been beaten up, so it's arguably a better time to buy it than, say, two years ago. Nonetheless, it's hard to get too excited about this or any other small-value fund right now, particularly given this fund's emphasis on the red-hot energy sector. If anything, we'd urge investors to lighten up on their holdings in the small-value space following the sector's multiyear runup.

Tweedy, Browne Value TWEBX
This fund, which reopened in mid-May, looks like a better contrarian play than the Diamond Hill fund. Although its managers aren't particularly sanguine about the market right now, they reopened so they could keep their powder dry in case of a correction. It's also worth noting that their financials-heavy portfolio boasts a number of stocks that Morningstar's equity analysts have rated as 4 or 5 stars. In addition, the fund recently raised its cap on foreign holdings to 50%; though its foreign stake isn't likely to go that high, the fund is a good outlet for the Tweedy team's best foreign-stock ideas. (Tweedy, Browne Global Value TBGVX is closed to new investors, though the firm recently opened a dividend-focused global fund.) Investors in search of a mild-mannered core fund that does a good job of preserving capital have a good one here.PAGEBREAK

Brown Capital Management Small Company BCSIX
Here's another fund that has been haunted by redemptions: Assets have dropped by half over the past five years, even though the fund has gained nearly 17% per annum over that stretch. Investors have no doubt bailed out because of the fund's roller-coaster returns--it followed up a 40% loss in 2002 with a 40% gain the following year. That erratic performance pattern demands a patient investor, but we take comfort in the fact that its up-and-down performance is an outgrowth of management's concentrated, low-turnover approach. (Like most of the best management teams, this one understands that stock prices swing around a lot more than company fundamentals do.) We recommend the fund in small doses.

Fidelity New Millennium FMILX
This fund has seen redemptions in the wake of longtime skipper Neal Miller's retirement, and we're similarly lukewarm on its prospects. Miller was a one-of-a-kind investor who used an eclectic, theme-based approach to generate fabulous long-term gains. We don't have anything against John Roth, who worked on several of Fidelity's sector funds before landing here, but we don't know him as well as we knew Miller. It's simply harder to make a case for this fund over better-known aggressive offerings at Fidelity or elsewhere. (If Fidelity Growth Company FDGRX were to reopen after having seen big redemptions, for example, we'd definitely be interested.)

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