fund info! Interesting!
Bigger funds can't buy smaller stocks.
Let's say a fund has $100 million in assets and shops among
stocks with an average market value of $500 million. Like
most funds, it seeks to have 1% to 2% of its assets in each of
about 100 stocks--meaning that its average purchase is $1
million to $2 million per stock. That's only a little nibble on the
typical stock. But if the fund grows to $1 billion in assets, a
1% to 2% purchase now runs between $10 million to $20
million, or a pretty big bite; and at a $10 billion fund, a 1% to
2% buy is a $100 million to $200 million. That's a monstrous
mouthful. In fact, if a $10 billion fund put 2% of its assets into
a stock with a $500 million market value, it would end up
owning 40% of the entire company.
Three bad things about that: Under federal law, funds are
generally forbidden from owning more than 10% of any one
company's stock. What's more, if a fund ever tried to sell all
those shares, the price of the stock would crash. And very
large stock purchases, especially in small companies, can cost
far more. Trading costs wear away at every fund's return like
sandpaper -- and the more each trade costs, the less return is
left for you. (For more, see "The Right Amount of Assets
Under Management," by Andre F. Perold and Robert S.
Salomon, Jr., Financial Analysts Journal, May-June 1991, pp.
31-39; this article, though somewhat technical, is one of the
most important ever written for fund investors. Keen insights
on the trading costs of mutual funds are also available at
[www.plexusgroup.com].)
Bigger funds buy too many stocks.
When funds get fat fast, they suddenly have hundreds of
millions of dollars in fresh money from their eager new
investors. It has to go somewhere. Look at AIM Aggressive
Growth: In 1990, when it had just $9 million in total assets, it
owned 53 stocks. Today, at more than $4 billion in assets, it
owns 355 stocks.
What's wrong with that? When a fund's money gets spread so
thinly across so many stocks, a great return from one stock
gets lost in the crowd -- and the effort to analyze and
understand too many stocks means the fund manager can't
spend very much energy and attention on each one.
That's why Warren Buffett, the best investor alive, puts nearly
all of his money into fewer than ten stocks. As he wrote in
1993: "in an investment lifetime it's just too hard to make
hundreds of smart decisions... Therefore, we adopted a policy
that required our being smart--and not too smart at that--only a
very few times." After all, the more stocks a fund owns, the
more often its manager has to be right -- and the less time he
has to study each stock. Those two things are fundamentally
at odds with each other--or, as Ambrose Bierce would say,
"incompossible."
Bigger funds have to pay too much for stocks.
Let's say you run the Weisenheimer Fund, and your favorite
stock is Smartaleck, Inc. You first bought it three years ago,
when your fund had only $10 million in assets and Smartaleck
was trading for just ten times earnings and two times book
value (about half the valuation of the average stock). But in
the meantime, the market has discovered Smartaleck, which
now trades at 45 times earnings and eight times book value
(nearly twice the valuation of the average stock).
Now that the Weisenheimer Fund is huge, with more than $5
billion to invest, what do you do? You can spread all this new
money across a bunch of stocks you've never owned before
(uh oh--that gets you into the "Bigger funds buy too many
stocks" problem above)--or you can pour it into the stocks you
already know, like Smartaleck. Only trouble with that is,
Smartaleck was dirt-cheap when you first bought it, but now
it's expensive. The odds that you'll make money on it are a lot
lower than they were when you first bought it.
If you're like most fund managers, you'll buy Smartaleck
anyway, because you understand the stock and you figure it's
better than the alternative, even if it is overpriced. Your
shareholders might not be better off that way, but at least you
made a decision.
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