Mutual funds now flinging open the doors

PERSONAL FINANCE

November 16, 2008|By EILEEN AMBROSE

For more than 25 years, the highly regarded Sequoia Fund was closed to new investors. But this past spring, the mutual fund once again flung open its doors to bring in more assets.

Sequoia has plenty of company. As stock prices fall and redemptions rise, many mutual funds that were off-limits for years are suddenly open.

A year or so ago, about 200 out of the 7,000 U.S. mutual funds were closed, says Russel Kinnel, director of mutual fund research at Morningstar Inc. Now, it's about 40 or 50.

Investment companies close funds to new investors for all sorts of reasons. Sometimes investors pour so much money into a fund that it's difficult for the fund to remain nimble or continue with its same investment strategy unless it shuts off the money spigot. That's usually the case for funds investing in shares of small companies.

Funds might close because they don't see good investment opportunities on the horizon, Kinnel says.

Vanguard Group, which reopened two funds last month, has closed funds that attracted short-term investors chasing returns, says spokeswoman Rebecca Cohen. When short-timers sell, they can raise the transaction costs of the fund for the remaining long-term shareholders, she says.

(Existing investors usually are still allowed to buy shares of the fund even after it's closed.)

The reasons for reopening a fund vary, too.

It could be that so many investors are bailing out that the fund reopens to bring in new money to offset redemptions. Others might reopen to raise money to snatch up bargains.

Also, if assets drop too low, a fund might have to raise its fees for existing shareholders, something funds are loath to do, says Tom Roseen, senior research analyst with Lipper Inc.

Mutual fund assets in September, for example, dropped more than 8 percent to $10.6 trillion because of redemptions and market declines, according to the Investment Company Institute's latest figures.

Dwindling assets also can affect a fund company's bottom line, Roseen adds. Fund companies that charge customers a percentage of assets under management can see their profits drop when assets shrink, he says.

The Sequoia fund was founded by Warren Buffett's former classmate, and the Omaha billionaire recommended it to his partners. The fund's largest holding is Buffett's Berkshire Hathaway.

Sequoia reopened in May because its investors are, well, getting up there. It was closed to new investors in late 1982.

"Not surprisingly, our shareholders have aged during this time to the point that attrition has become an issue for the fund," officials said when announcing the reopening. Despite a long history of investment gains, the fund's assets in March had dropped to $3.5 billion, lower than they were a decade earlier.

"Someone called it 'refreshing the shareholder base,' " Kinnel says.

The Longleaf Partners Fund and International Fund closed in 2004 because of a lack of investment opportunities, says Lee Harper, vice president of Southeastern Asset Management, which manages the funds. The International fund reopened last year; the Partners fund that invests in midsize to large U.S. companies reopened in January. "In this environment, there are a lot of great investment opportunities," Harper says.

Similarly, Wasatch Funds reopened three micro-cap funds this year, pointing to buying opportunities in the market.

So should you rush into a fund that has recently reopened before it shuts its doors again to new investors?

Not so fast.

Find out why the fund is reopening. You might not want to invest if other shareholders are bailing out because the fund is severely underperforming compared with its peers.

And you still need to check the fund's basics. Has the fund manager changed since it first closed? If so, what is the new fund manager's track record?

Don't overlook fees. High fees eat away your return.

And beware of capital gains distributions, something you need to consider when buying a mutual fund near the end of the year through a taxable account. Funds must distribute gains to shareholders annually by year's end. So even if you are invested in the fund for a few weeks, you could get hit with taxes.

Sequoia told shareholders at the end of March that the fund traded at $132.29 a share, with unrealized capital gains accounting for about $59 of that. Fund officials warned that when appreciated securities are sold and the profits are distributed, shareholders in taxable accounts will owe taxes on the gain, no matter when they invested.

A fund usually gives investors a heads up when it plans to make capital gains distributions. You can also call the fund or check its Web site. If you are investing through a taxable account, wait until after the distribution or early next year before purchasing shares, Kinnel says.

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