Morningstar Magazine - February/March 2014 - 48

Strategies:
Investment Research

Drawing the Line of Asset Bloat
By Russel Kinnel

Investors should take notice when their favorite funds
swell in size.

Every fund investor with gray hair knows the
Icarus-like story of Fidelity Magellan FMAGX.
It was brilliant, but, after Peter Lynch left, it
was run by mere mortals even as its asset size
soared ever higher. It was the biggest fund
by far, and that proved its undoing. It has been
a weak performer for nearly two decades, and
it has fallen back to earth. The fund surpassed
$100 billion, but today it's a humbled 2-star
fund with just $16 billion in assets.

than the one they bought. And it showed
in performance, too. For the trailing 10 years
through Dec. 31, 2013, this once-strong
performer's 8.3% annualized return ranks in
its category's bottom quartile. Franklin
MicroCap Value FRMCX, run by the same
team using a similar process, closed in the
beginning of 2001 with assets at a mere
$110 million. Its 10-year return by contrast
was 10.4% annualized.

But there have been other, less famous
stories such as Calamos Growth CVGRX, which
was great when it was small and pedestrian
when huge. There's also Franklin Balance Sheet
Investment FRBSX. (See Exhibit 1.) It became
popular quickly by making money in 2000 and
2001, then losing only a little in 2002. The
fund gained $500 million in new flows in 2001
and an additional $941 million in 2002. It
closed to new investors in 2002, finishing the
year with a total of $2.5 billion in assets.

I wouldn't say assets were the only difference
here, but they were important. And before
you accuse me of pulling a Malcolm Gladwell
by stringing together a few anecdotes as
though that proves something, I offer an
example of a fund that was not ruined by
asset growth. T. Rowe Price Small-Cap Value
PRSVX closed in May 2002 with assets of
$3 billion. It, too, had been borderline microcap. But it didn't migrate to mid-cap land.
It moved up slightly but has remained near the
low end of small caps. And its returns are
a nifty 10.9% annualized during the trailing
ten-year period.

That was a pretty quick close, but it might
have been too late. The fund tripled in size
from 2000 to 2003 and grew to $5 billion
in 2006. Management moved the fund from
borderline micro-cap (around $250 million
average market cap) to the small/mid border
just as rapidly from 2000 to 2003 as illustrated
in the graph. The little dot is the first portfolio
in 2000 and on up to the biggest dot in 2003.
Thus, investors ended up with a different fund

48 Morningstar February/March 2014

Why the difference? Maybe T. Rowe's
larger analyst staff gave it greater capacity.
Maybe the existence of Franklin MicroCap
Value beneath it put pressure on Franklin
Balance Sheet to stand out from its sibling.
Either way, the data suggest 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. Morningstar has seen funds have
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 when buying and selling shares.
Because liquidity is a key issue with
trading costs, smaller, faster-trading strategies
are more vulnerable than those with large
caps and low turnover. Funds in the lower-righthand corner of the Morningstar Style Box
are most sensitive to bloat, and they get less
sensitive as you move to the upper left.
Morningstar Magazine - February/March 2014

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