Say you are reading the paper and you notice that a certain 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? Listed below are the characteristics of closing funds, the reasons why they close and key factors that you must consider when evaluating a closing fund.

SEE: Open Your Eyes To Closed-End Funds

Closed Funds Vs. Closed-End Funds
It is important for us to differentiate between a closed fund and a 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) that can only be bought or sold through an exchange.

Closed funds are 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 shareholders can still buy shares of the fund after its doors have closed to the public. In a "hard close," which is rarer, a fund does not accept new money from new or existing shareholders.

Why Funds Close
The biggest reason why a mutual fund company will decide to close its fund's doors is that the fund's strategy is being threatened by the fund's size. Funds that tend to outgrow themselves the most are small cap funds or 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.

Furthermore, a large influx of cash may compromise the manager's ease in performing trades. It is much easier for a 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 reorganization.

SEE: Are Bigger Funds Always Better?

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 prior 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 and when is the closure is actually 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 agency problem, a conflict of interest that can arise between creditors, shareholders and management because of differing goals, is the main reason many funds 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/overall market conditions. A fund that consistently outperforms the market is a rare find, and over the long run, funds tend to converge to an average rate. funds, see

SEE: Can You Pick the Winners at the Mutual Fund Track?

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 he or she moves 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 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 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 closing 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.

Related Articles
  1. Mutual Funds & ETFs

    Top 4 Dodge & Cox Funds for Retirement Diversification in 2016

    Find out the four Dodge & Cox mutual funds to use to create a well-diversified retirement income portfolio and learn why they're unique.
  2. Mutual Funds & ETFs

    Pimco’s Top Funds for Retirement Income

    Once you're living off the money you've saved for retirement, is it invested in the right assets? Here are some from PIMCO that may be good options.
  3. Mutual Funds & ETFs

    3 AllianceBernstein Funds that Are Rated 5 Stars by Morningstar

    Discover the top three mutual funds administered and managed by AllianceBernstein that have received five-star overall ratings from Morningstar.
  4. Mutual Funds & ETFs

    Top 4 Davis Funds for Retirement Diversification in 2016

    Discover the four best mutual funds managed by Davis Advisors that pursue different investment strategies that can help diversify retirement portfolios.
  5. Mutual Funds & ETFs

    Is Morningstar’s Star System An Effective Ranking Tool? (MORN)

    Learn why Morningstar's star rating system is not always a great predictor of future performance, and why investors should not pick funds on star ratings alone.
  6. Mutual Funds & ETFs

    5 Vanguard Fixed Income Fund Underperformers

    Learn about three Vanguard fixed income mutual funds that underperform compared to their benchmark indexes. Find out why low expense ratios are important.
  7. Mutual Funds & ETFs

    Top 5 Natixis Funds for Retirement Diversification in 2016

    Discover five mutual funds from Natixis Funds that provide high income, growth and preservation of capital while diversifying a retirement savings plan.
  8. Mutual Funds & ETFs

    4 Mutual Funds You Wish You Could Include In Your 401(k)

    Discover four mutual funds everybody wishes were in their 401(k)s. Learn which five-star-rated no-load funds leave their competition in the dust.
  9. Mutual Funds & ETFs

    Top 3 Allianz Funds for Retirement Diversification in 2016

    Discover the top three Allianz funds for retirement diversification in 2016, with a summary of the portfolio's managers, performance and risk measures.
  10. Mutual Funds & ETFs

    3 PIMCO Funds Rated 5 Stars by Morningstar

    Learn about three fixed income mutual funds managed by Pacific Investment Management Company (PIMCO) that have received five-star overall ratings from Morningstar.
RELATED FAQS
  1. Are target-date retirement funds good investments?

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement ... Read Full Answer >>
  2. Do mutual funds require a demat account?

    A dematerialized account enables electronic transfer of funds. The account is used so an investor does not need to hold the ... Read Full Answer >>
  3. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
  4. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  5. Does OptionsHouse have mutual funds?

    OptionsHouse has access to some mutual funds, but it depends on the fund in which the investor is looking to buy shares. ... Read Full Answer >>
  6. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
Hot Definitions
  1. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  2. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
Trading Center