Perhaps you are scanning the headlines one morning and you notice that a certain mutual fund will be closing its doors to new investors by the end of the current business day. What exactly does this mean? Should you rush to invest in it, increase your holdings in it, or rush to sell your holdings? Listed below are the characteristics of closing mutual funds, the reasons why mutual funds close, and key facto♛rs you should consider when evaluating a mutual fund that is closing.

Closed Funds vs. Closed-End Funds

It's important to be able to differentiate between a 澳洲幸运5官方开奖结果体彩网:closed fund and a 澳洲幸运5官方开奖结果体彩网:closed-end fund. Closed-end funds are mutual funds that, at their initial creation, issue a fixed number of shares to the public, which thereafter are structured as stock (actually, a basket of stocks or bonds) ꦐthat can only be bought or sold through an exchange.

Closed funds are 澳洲幸运5官方开奖结果体彩网:open-end funds that will no longer accept money from new investors (investors who do not currently own any shares in the fund). For closing funds performing a "soft close," existing 澳洲幸运5官方开奖结果体彩网:shareholders can still buy shares of the fund after its doors have closed to the public. In a "hard close," which is ღrarer, a fund does not accept new money from new or existing shareholders.

Why Do Mutual Funds Close?

The biggest reason why a mutual 澳洲幸运5官方开奖结果体彩网:fund company will decide to close its fund's doors is that the fund's strategy is being threatened 澳洲幸运5官方开奖结果体彩网:by the fund's size. Funds that tend to outgrow themselves most frequently are 澳洲幸运5官方开奖结果体彩网:small-cap funds or 澳洲幸运5官方开奖结果体彩网:focused funds. When a fund performs well, many new investors are willing to invest their money into it, but because small-cap funds deal with low-volume stocks and focused funds prefer portfolios containing only about 20 shares♌, large amounts of assets will hinder the strategy of either type of fund.ꦅ

Furthermore, a large influx of cash may compromise the manager's ease in performing trades. It is much easier for a 澳洲幸运5官方开奖结果体彩网:fund manager to shuffle $500,000 worth of stock than it is to shuffle $10 million worth. The decision to close a fund's doors to new investors could be to protect existing shareholders from stagnant or declining fund performance. Open-end funds could also choose to close if they are planning a 澳洲幸运5官方开奖结果体彩网:reorganization.

Performance of Funds After Closure

What effect does closure have on the fund's performance? Well, it's hard to say, but investors should be aware that some closed funds tend to have a less attractive performance after closure. Morningstar's Guide to Mutual Funds, published in 2003, cites a study in which Morningstar tracks the performance of a group of open-end funds that closed their doors to new investors. The funds in the study were of the top 20% of the funds within their categories prᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚior to closing. However, 🍰three years after their closure, 75% of the funds dropped to an average performance.

The lower returns may not necessarily be a direct result of the closure itself, but may instead be a result of the problems the fund was experiencing already before it closed its doors. However, when a fund's closure is an indication of problems then the closure can actually be a signal of prudent management.

When It's Bad News

Many funds do not decide to close their doors to new investors until the fund's performance has already been damaged by its growth. The 澳洲幸运5官方开奖结果体彩网:agency problem, a 澳洲幸运5官方开奖结果体彩网:conflict of interest that can arise between 澳洲幸运5官方开奖结果体彩网:creditors, shareholders, and management because of differing goals, is the main reason many fun🍒ds do not close their doors sooner. Because fund companies bring in more money (in fees) by attracting investors, a fund's drive to increase its profitability may keep it open too long. Also, some fund managers' compensation is tied to the size of the fund, so these 🦂managers have the incentive to manage increasing amounts of portfolio assets.

It is important for investors to realize that some closed funds do not perform as well simply because of the normal market conditions. A fund that consistently 澳洲幸运5官方开奖结果体彩网:outperforms the market is a rare fღind, and over the long run, funds tend to converge to an average rate.

When It's Good News

The large influx of funds from investors, on the other hand, sometimes indicates the fund manager's superior skill in picking assets for the portfolio. Some funds, when they are first created, set a limit on the maximum amount of assets they can handle. The closure of this kind of fund is a sign that the fund manager is working to maintain the fund's original investment goals and the efficiency with which they move the fund's assets. This fund would see a higher chance of performing well after closure.

The Door Is Shut, but Not Locked Forever

Open-end funds can choose to open and close their doors as they see fit. Consider the Hartford Midcap Fund, which initially closed its doors in September of 2001. Its 澳洲幸运5官方开奖结果体彩网:net asset value at that time was around $15 a unit, a significant drop from the fund's peak of $23, which occurred at end of the previous year. The downward slope from the $23 peak indicates that the fund manager was starting to have extreme difficulty in maintaining the fund's mid-cap strategy.

Figure 1

Source: BarChart.com

The fund's performance regained ground over the next year as a closed fund, only to be reopened again in the summer of 2002, when its performance began to drop again. The fund closed its doors again to investors in the summer of 2003.

Stay In or Get Out?

If you currently hold units of a fund that has announced it will be closing its doors to new investors, do you want to squeeze out through that door, or should you stay? Just because your fund is🐬 closi🍎ng its doors to new investors doesn't necessarily mean that you should expect to lose money in the future, especially if the closure is a prudent and timely decision.

The Bottom Line

When your fund or prospective fund is closing, knowing the positive and negative implications of the closure is important for deciding what to do, especially because you'll usually have a short period of time to act. Determining whether the fund is already damaged or whether it's maintaining its strategy, and therefore saving itself from compromising its goals, should be key when you're evaluating a fund's closure. Remember to direct your investments or they will direct you.