Don't Bail on These Asset-Losing Funds
Despite net outflows during the past half decade, these equity funds are still worthy of your consideration.
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Hearing that a fund is experiencing significant outflows might give one pause as to whether to buy it, or cause shareholders to consider selling. If other investors are pulling assets from the fund, it must mean something's wrong with it, right?
Not necessarily. In fact, lousy funds aren't the only ones in which investors lose confidence. Sometimes quality funds lose assets, too. As discussed in this earlier Five-Star Investor article, a number of large actively managed funds have seen enormous outflows since the 2008 financial crisis--with selections from American Funds, in particular, taking a pounding. Yet several funds on the list carry Morningstar Analyst Ratings of Silver or Gold, meaning they are considered among the best in their categories, and a few have even been among the better performers in their categories during the past five years.
Undoubtedly some of these outflows are attributable to investors increasingly turning to passively managed investment products such as index mutual funds and exchange-traded funds. But the numbers also should be viewed in the context of the net outflows seen across all domestic-equity funds (active and passive combined) each year from 2009 to '12, a streak that may finally end in 2013 (more than $26 billion was added to U.S.-equity funds through the first nine months of the year).
Clearly, losing assets need not be seen as an indication that a fund's quality is diminishing. Rather, in some cases, losing assets can be beneficial. Consider a fund with a large asset base, that, because of its girth, shies away from some small-cap stocks. A large fund might do this because owning enough shares of a small-cap company to make a difference in the fund's performance might mean driving up the company's share price (as a result of the stock purchases), thus reducing the benefit of owning the stock in the first place. With a smaller asset base, the fund can afford to buy shares of smaller companies without inflating their prices. In this way, having a smaller asset base allows funds to be nimbler than their larger-asset counterparts. (Note that a fund which has had net asset outflows may still see its asset base rise as a result of appreciation and income from its holdings.)
One potential downside to a shrunken asset base involves fees. With fewer assets under management, the fund could be forced to raise fees to cover its expenses. For this reason investors who like a fund but notice its asset base is shrinking should keep an eye on what the fund is charging them. Another downside is that as a fund loses assets, its management team could be forced to sell the fund's more liquid holdings--whether it wants to or not--if it has trouble unloading more illiquid ones.
Let's take a closer look at a trio of funds that have seen significant outflows in recent years, and why Morningstar's fund analysts continue recommended them.
Dodge & Cox Stock (DODGX)
An example of a fund that investors have not used well, this large-value offering has returned 10.9% per year during the five-year period ended Sept. 30, but on average its shareholders saw only 9.0% of those returns. The fund's overweighting of financial-services stocks during that time period most likely contributed to the net outflows, particularly in 2011, when the fund's 4% loss put it near the bottom fourth of its category. Of course, those shareholders who stuck around have seen a healthy rebound as financials have bounced back (they remain at around 22% of the portfolio--about average for the category). The fund's one-, three-, and five-year annualized returns all land in the top decile of the large-value category, and its top-fourth 10-year annualized performance speaks to its managers' strong long-term record despite the fund's above-average volatility. At 0.52%, fees are low for a large-cap, no-load fund. Morningstar fund analyst Laura Lallos says the fund "embodies traditional investment values such as intensive research, low turnover, and low expenses," but cautions that "this fund is not a conservative investment."
Weitz Partners Value (WPVLX)
Strong outflows and a declining stock market during the financial crisis left this fund, which finished 2007 with an asset base of $1.5 billion, with just $467 million in assets by the end of 2008. Performance since then, however, has been exemplary, with 19.2% annualized gains during the five-year period ended Oct. 21 that beat the S&P 500 by 3.8 percentage points per year. The fund, led by longtime manager Wally Weitz, takes an all-cap approach in seeking out good companies run by excellent capital allocators that it can own for years, says Morningstar fund analyst Kevin McDevitt. However, its contrarian approach can lead to lumpy returns, and its 1.19% expense ratio is above-average for a large-cap, no-load fund, though not entirely surprising given its small asset base.
Fidelity OTC (FOCPX)
This large-growth fund has rebounded from a poor 2012, in which its 11.3% gain trailed its category average by 4 points, to post stellar gains in 2013. As of Oct. 21 the fund had returned 37.6%, more than 11 points better than the category average. Manager Gavin Baker looks for long-term and short-term growth stories, including companies with durable competitive advantages and strong earnings as well as companies he believes will experience significant earnings upside in the next year.Baker's consistently strong stock-picking skills remain key to this fund's appeal, says Morningstar analyst Janet Yang. The fund charges 0.74% in expenses, which is below-average for a large-cap, no-load fund.