Small Is Beautiful

Stabilizing Influence
Small investors are generally portrayed as being prone to herding. Ask George Bailey, who pledges $2,000 of his honeymoon funds to placate frightened customers making a run on the old Building & Loan. Consider also the retail fund buyer, frequently blamed in the 1980s for pushing up Treasury prices when buying long government bond funds in the mid-80s, then for pushing Treasury prices down when they later sold those funds. Circa 2000, mutual fund owners were widely regarded as the biggest threat to stock market stability because, it was believed, at the first sign of trouble the novice 401(k) owner would panic and sell stocks into a downturn.

Yesterday, however, the SEC reversed the image of the lemming retail investor. In a statement on money market fund regulations, SEC Chair Mary Jo White said, "The first proposed alternative [to current rules] would require that all institutional prime money market funds operate with a floating net asset value (NAV) ... This floating NAV proposal specifically targets the funds where the problems during the financial crisis occurred: institutional, prime money market funds. Retail and government money market funds--which have not historically faced runs in even the worst of times--would be exempt from the proposed floating NAV requirement." Yes, that's right, the SEC said that individuals are less apt to herd than are institutions.

It's about time. Morningstar analysts learned long ago from conversations with investment managers that small fry provide the stickiest assets. The retail owner, by and large, is willing to shrug off short-term performance problems. Institutional investors, on the other hand, are paid to take action, and they're measured against the performance of other institutions. So when bad news arrives, institutions are not only quicker to sell than are consumers, but they are likelier to look over their shoulders and emulate what others are doing. Which is how panics occur.

Change Begets Change
Another thing that quickly becomes evident to a new Morningstar analyst is how fund companies differ in their levels of manager turnover. Some firms rarely lose staff, while others constantly seem to be slapping stickers on prospectuses and introducing new personnel.

Recently, Morningstar's Russel Kinnel ran the numbers. The effect is even larger than I expected. I can't link to the data as Russ' story will shortly run in Morningstar FundInvestor, but I can summarize the results. Funds that had no manager changes over a five-year period had an average of 1.1 changes over the next five years. Kicking it up a notch (as Emeril would say), funds that had one manager change over a five-year period had 1.53 manager changes over the next five years--a rate 40% higher than that of the previous group. The numbers climb steadily; in the highest bucket that Russ created, funds having more than three manager changes over five years, the average was 3.0 manager changes for the next period.

It's true that Russ' data set is affected by the number of managers that a fund lists. Funds with multiple managers will have more turnover than funds with a single manager. But the findings still hold. For example, American Funds is famous for its multimanager approach, but it shows up in Russ' study as among the most stable of large fund companies. No matter how you slice the data, fund companies that have kept their personnel in the past are likelier to do so in the future.

It's Always a Good Time to Buy Dean Witter
Many years back, when Dean Witter ran mutual funds, the company finished every shareholder letter by writing, "Now may be a good time to add to your shares of [the name of the fund]." It wrote that for every fund in every asset class in every market. It was always a good time to buy Dean Witter. (Actually, it was rarely a good time to buy Dean Witter, which is why those funds no longer exist.)

In that spirit, I salute PIMCO Founder Bill Gross, who recently tweeted, "I like PIMCO portfolios here. Well rested/well positioned for future opportunities."

Remember, friends, it's always a good time to buy PIMCO!

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.