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Fund Spy

Four Funds That Should Consider Closing

These mutual funds are looking a tad bloated.

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In the fund world, success can be a dangerous thing. Strong returns grab investors' attention and bring a torrent of new cash for the manager to invest. The benefits of that extra money may include falling operating expenses. But as more and more cash floods in, a hidden expense--the cost of trading--begins to rise. In addition, the manager may be forced to change his or her investing style to adapt to the fund's new girth. That's the irony. People rush in, hoping for a repeat of the past. Yet by rushing in, people change a fund in ways that may inhibit its ability to repeat the past. I'll cite four examples.

When a fund gets too big, it's rarely a disaster; typically, it spreads its bets out over more stocks, and performance becomes more like that of an index or the typical fund in the category. I can think of much worse results than that--but who picks a fund with the idea of enjoying average performance? Plus, asset bloat doesn't just lead to greater diversification. It can increase trading costs because the fund's trades push a stock's price further away from the initial trading price. It can also lead the manager to alter strategy by investing in more-liquid stocks, trading less and, as mentioned, diversifying more--all virtuous things, but probably not what made the fund excel.

Royce Total Return
 Royce Total Return (RYTRX) is one of the largest small-company funds in existence, yet it remains open. From 2000 to today, the fund has grown from $280 million in assets and 150 holdings to $6 billion and 450 holdings. In addition, lead manager Chuck Royce has about $5 billion more under management in other funds. On the plus side, Royce uses a low-turnover strategy, which is a little less sensitive to asset bloat. Even so, this fund will be hard-pressed to match its past strong results because any single idea will contribute only a small amount to the fund's returns. Indeed, the fund's three-year returns are already subpar.

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Russel Kinnel does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.