Smarter Ways Funds Are Staying Slim

Not too many years ago, closing a mutual fund was a straightforward operation. When a firm thought one of its funds had gotten too big, it simply shut the door to new investors. Those already in the fund could continue sending money. Sometime in the future, when assets seemed more under control (often because the fund's sector had tanked and shareholders had fled), the fund reopened its doors to everyone.

Recently, though, funds have become more creative in managing their asset flows. In doing so, they have adopted (probably not consciously) the techniques long used by urban nightclubs. I'm referring to those trendy nightspots where burly, well-dressed gatekeepers eye a stylish crowd massed behind velvet ropes. Rarely do such places throw their doors open to all comers. Sloppy dressers, for example, stand little chance of gaining entry. Yet the clubs tend not to slam their doors completely shut, either; a famous face will likely be waved right in even if the place is packed. Such flexibility, though frustrating to the ordinary folks who'll never get off the sidewalk, allows the nightclub to keep just the right amount of party going on inside.

Thankfully, funds--unlike nightclub doormen--aren't choosing their shareholders on the basis of fame or stylishness. But fund families, too, have begun using more nuanced methods to maintain their funds' assets at reasonable levels. On the whole, we approve of the change of habit. The availability of more flexible methods can mean that at least some investors still will be able to get into fast-growing, high-quality funds, rather than being shut out indefinitely as they would be if such funds simply adopted the standard closing. Firms reluctant to actually close their funds also might be more willing to use these halfway methods, thus preventing the funds from getting as bloated as they otherwise would.

In fact, it's quite possible that these calibrated methods will prove even more effective at managing a fund's inflows and outflows than a standard close. That, too, would benefit long-term shareholders in such offerings.

One method to more effectively manage fund flows is to raise the minimum investment. Vanguard and some other firms have taken this approach with funds they thought were growing too large, hiking the minimum investment to $25,000 from $3,000 or $5,000. While that puts the funds out of reach for some investors, it keeps them available for others.

Some firms also have adopted different rules for different channels. For example,  Fidelity Low-Priced Stock (FLPSX), which instituted a typical close in late 2003, went one step further this past summer. It shut off access even to potential new investors in group retirement plans that already had the fund on their menu. It also imposed a limit on the size of aggregate ownership stakes of large advisors. This was an alternative to taking the most drastic step--shutting the fund to everyone, including current shareholders. Such a "hard" close is rarely used. (One could argue that with this particular fund, an extreme case of a small-cap offering that grew to gigantic size, Fidelity waited too long to take decisive action, and perhaps even a hard close would have been appropriate.)

A similar way for a no-load fund to slow the pace of inflows is to stop accepting new accounts from supermarkets such as Schwab while continuing to allow investors who contact the firm directly to open new accounts. The Oakmark fund family has taken that approach recently.

Creativity has also come into play when funds reopen.  Vanguard Global Equity (VHGEX) closed to new investors in late 2003; its subadvisor was getting so much new business--both in the fund and in other accounts--that it felt it had to stop and take a breather. After a while, though, Vanguard wanted to reopen the fund. So a few weeks ago, it did--by adding a new subadvisor to take the bulk of new inflows.

Of course, it would be wrong to grant blanket approval of all such moves. This last approach, for example, could prove detrimental to shareholders if a fund company, eager to reopen a popular fund, adds a subadvisor that isn't all that talented. (For the record, that's not a concern for Vanguard Global Equity, whose new subadvisor is quite competent.) Or a rapidly growing fund might raise its minimum instead of simply closing its doors, even though it's far past the stage when such a halfway step might be acceptable.

But it's worth remembering that the standard methods can be misused, as well. For example, some funds have set a closing date well into the future, then have used that deadline as a marketing tool, urging new investors to buy the fund before it was too late. A fund treated in that way could grow substantially larger, defeating the entire purpose of the closing.

Therefore, despite the possibility for abuse, the availability and growing acceptance of more creative and flexible methods of fund-flow management seem to be positive steps. Certainly it will pay to keep a close eye on how they are used and whether they achieve their intended goals. But for the most part, it should be helpful for fund families to have more options at their disposal in dealing with a very tricky, yet very important, problem.

Fund Fee Update
This summer I pointed to three good international funds that had reduced or were about to reduce their cost. One of them,  Neuberger Berman International , had not yet specified what its new fee would be. Now it has, and it's good news. The still-rather-small fund has installed a cap of 1.40% on its expense ratio, which is well below average for no-load funds in its category and far more reasonable than its previous level, which had been 1.70% or more. Meanwhile, another fund mentioned in that article, Schwab International MarketMasters, now goes by the name  Laudus International MarketMasters  , but everything else about the fund remains the same.