2
returns are a nifty
11
.
4%
annualized—a hair better
than either Franklin fund.
Why the difference? Maybe T. Rowe’s larger analyst
staff gave it greater capacity. Maybe the existence of
Franklin MicroCap beneath it put pressure on Franklin
Balance Sheet to stand out from its sibling. Either
way, the portfolio statistics and performance suggest
that asset bloat was a bigger problem for Franklin
Balance Sheet.
The Problems of Asset Bloat
Asset bloat can force a manager to alter his strategy.
We’ve seen funds have tremendous success with
small caps only to later forgo small caps because they
weren’t practical.
A manager dealing with asset bloat can also add more
positions. That’s tricky, too, because the fund might
not have enough analyst depth to fully research those
new names. A bigger portfolio also means the fund
now gets less out of its highest-conviction names and
perpetually needs to pick more winners. Calamos
Growth had problems when asset bloat outstripped
its ability to research new names.
A manager can also deal with asset bloat by trying
to do exactly what he did before. The problem there is
that trading costs will surge. If a
3%
position amounts
to $
50
million of fund assets and the manager doesn’t
move up in market cap, that means buying a much
bigger piece of a company. In turn, that could lead to
higher trading costs or greater market impact, mean-
ing the fund drives up the stock price when it buys in
greater volume and drives it down when it sells.
Because liquidity is a key issue with trading costs,
smaller, faster-trading strategies are more vulner-
able than those with large caps and low turnover.
Essentially, funds in the lower-right-hand corner of
the Morningstar Style Box are most sensitive to
bloat, and they get less sensitive as you move to the
upper left.
A less common, yet still irksome asset-bloat problem
is hot money. When
Fairholme
FAIRX
surged to $
19
billion from $
6
billion in just two years, manager
Bruce Berkowitz argued that the added heft enabled
him to get a seat at the table and do bigger deals
than he could do before. However, what he hadn’t
bargained for was just how quickly those assets
could leave. When a fund has amazing returns and
stays open, it can get some very hot money. Hot
money chases the very best performers and thus is
prone to leave at the first downturn. When everyone
runs for the door, it can cause huge headaches way
beyond the challenge of mere asset bloat. That’s
what happened when Fairholme had a terrible
2011
.
Heavy redemptions meant Berkowitz had to sell
stocks he didn’t want to, and it dropped the fund’s
cash position lower than he wanted it. These things
in turn made performance worse.
A chastened Berkowitz later closed the fund in the
hopes of keeping hot money out. It’s a good reminder
that, in an open-end fund, it matters who your fellow
shareholders are.
Asset bloat is sneaky because it is rare that it is the
main driver of a fund’s single-year performance.
Asset bloat can be a handicap, but a bad year doesn’t
prove its existence, just as a good year doesn’t
prove it doesn’t exist. For example, both
Fidelity
Magellan
FMAGX
and
Fidelity Contrafund
FCNTX
suffered from asset bloat. However, Magellan got
much larger, and its managers post-Peter Lynch were
less able to adapt than Will Danoff has been at
Contrafund. Contrafund was closed for a while, but
Danoff has kept doing a remarkable job even as
his total assets have grown above $
100
billion. We
pay attention to asset bloat even with the knowledge
that the Danoffs and Joel Tillinghasts (
Fidelity Low-
Priced Stock
FLPSX
) of the world may be able to
overcome it. Even they, though, would likely have had
even better performance with smaller asset bases.
Pulling Your Coat to Bloat
So, how do you know if a fund is getting too big?
As you can see, the picture is a little fuzzy. But I
pulled together some data to let fund managers serve
as your guide. I looked at the median asset bases
at which funds closed at different market-cap levels.
Drawing the Line on Asset Bloat
Continued From Cover
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