For months, advisors looking to invest in a solid small cap fund have been faced with a growing problem: Many of the best ones have been closed to new investors. Of the 301 small cap value funds tracked by Morningstar, 33 are closed. About 10 percent of small blend and small growth funds also are barring new investors. Closed funds include top performers AIM Small Cap Opportunities, Neuberger Berman Genesis, State Street Research Aurora and Wasatch Core Growth.
For decades, companies occasionally would shutter a fund; the real wave of closings began only in the late 1990s. At the time, cash was pouring into funds, and investors and advisors had begun complaining that too many portfolios were bloated, causing funds to trade ineffectively, thereby hurting returns and penalizing long-time shareholders. The issue was particularly acute at small cap funds. Their returns often dropped as asset size increased. In some cases, small cap managers sought to absorb cash flows by buying large cap stocks. But this infuriated advisors who said the shift in holdings would distort asset allocation plans.
In response, fund providers began pledging to close funds when assets reached a certain level. PBHG Ltd., a small cap growth vehicle, closed the day it opened, as assets poured in; Bogle Small Cap Growth shut soon after its inception; dozens of small cap value funds closed during the past few years as returns surged and investors raced to jump aboard.
While the closings may frustrate would-be investors, many “closed” funds still permit existing shareholders to invest additional cash. And, in some cases, the manager of a closed portfolio also operates a similar fund that remains open.
If there are ways to access a closed fund manager, should you do it? Probably not. According to a Morningstar study, the performance of funds tends to drop sharply after they close. The researchers looked at the returns that funds achieved for the three years before closing and the three years after. On average, the funds had been in the top 20 percent of their categories before closing. During the next three years, they slipped to the bottom 40 percent.
Part of the problem may be that fund companies wait too long to act. By the time a fund closes, it has already become too big to deliver top performance. Also, funds close after investors have raced into them, and that often occurs when a hot fund has peaked and is about to enter a period of being out of favor. “If a fund announces that it will close in a month or two, then you should probably buy something else,” says Sheldon Jacobs, editor of No-Load Fund Investor, a newsletter in Ardsley, N.Y.
A Buy Signal?
After closing, many funds eventually reopen. This often occurs because the investment strategy has turned cold, and shareholders have made withdrawals. Some analysts suggest that fund reopenings signal an intriguing opportunity to invest, insofar as the funds are losing assets as shareholders throw in the towel.
One fund worth watching is T. Rowe Price New Horizons, the oldest small cap growth fund. Since it started in 1960, New Horizons has opened and closed several times. T. Rowe Price shut the door in March 1972, at a time when growth stocks were soaring. The fund reopened in September 1974, which proved to be near the bottom of a vicious downturn. “We never attempted to time the market,” says Steven Norwitz, vice president at T. Rowe Price. “We closed the fund when valuations were clearly too high to invest the money reasonably. When valuations seems reasonable, we opened it.”
After small growth stocks enjoyed a period of blazing growth, the fund closed again in June 1996. Soon small stocks slowed and large caps began dominating the markets. New Horizons remained closed until May 2002, when it reopened. At about the same time the company reopened this small cap growth fund, it closed T. Rowe Price Small Cap Value. Investors had poured more than $500 million into the value fund during the first quarter of the year, Norwitz says — too much cash for the manager to handle.
Do the moves by T. Rowe Price suggest that investors should start to emphasize growth instead of value? “A lot of people are badmouthing growth stocks now, and that could be a sign that it's time to buy,” says Don Dion, president of Dion Money Management, an RIA in Williamstown, Mass.
Other money managers share that optimism. In recent months, a few closed growth funds have reopened, including Janus Olympus, Buffalo Small Cap and Bjurman-Barry Micro-Cap. In announcing the shift, the Janus fund's manager, Claire Young, said she was reopening the fund to take advantage of the compelling opportunities that had become available.
Norwitz of T. Rowe Price cautions that his funds sometimes reopen well before the market shifts, but he argues that small growth stocks are attractive. As evidence, Norwitz notes that investors have long monitored the valuation of T. Rowe Price New Horizons, considering it a proxy for the asset category. The rule of thumb is that small growth stocks are overvalued when the fund's P/E ratio is twice the figure for the S&P 500. When the fund's P/E drops to that of the S&P, it's regarded as a good opportunity to buy small growth. As of mid-October, the fund was trading at about 1.4 times the P/E figure of the S&P, perhaps suggesting that small growth stocks may be fairly valued — though not selling at a discount. But Norwitz argues that technology stocks continue to be overpriced and have inflated the average multiple. Without technology, the New Horizons P/E is close to bargain territory. If Norwitz is right, more small growth funds will likely open soon and investors who buy now should enjoy a nice ride.
When the Gate Swings Open
Many investors race to grab hot funds just before they close, but a better time to buy may be after a fund has been closed for a while and has just reopened. Below are funds that have recently reopened.
|Fund||Ticker||Category||1 Yr||3 Yrs||5 Yrs||Expense|
|Micro-Cap Growth||BMCFX||small growth||-5.9*||26.5||20.5||1.80%|
|Buffalo Small Cap||BUFSX||small growth||-15.01||2.8||NA||1.01|
|Janus Olympus||JAOLX||large growth||-20.6||-13.9||5.9||0.89|
|Small Cap Value||NISVX||small value||13.3||21.2||NA||1.67|
|T. Rowe Price|
|New Horizons||PRNHX||small growth||-22.3||-4.0||-0.1||0.91|
|*Returns through 8/31.|