Mutual Funds

When to Make a Clean Break From Your Funds

Deciding which funds to ditch is just as important as which to buy.

By Andrew Tanzer, Senior Associate Editor, Kiplinger's Personal Finance

June 2007

Investing in a mutual fund is like entering a relationship. You should know your partner well; after all, you're going to be together during good times (bull markets) and bad (bear markets). And no matter how attached you get to your fund, sadly, sometimes you'll need a divorce. Consider a breakup if you find yourself in one of these situations.

Change of portfolio manager

You did your homework before you bought a fund, and you have faith in the fund's manager. But what happens when he or she departs?

This is often, but not always, a time to sell the fund. First, research the new manager's track record (if there is no track record, sell). If the manager has a long record running a similar fund with like performance, then you're in good shape.

Occasionally, the new manager can fill the old one's shoes, if he or she has been schooled at the master's knee and groomed to take over. For example, when the legendary Michael Price retired, Mutual Series scarcely missed a beat because David Winters, his lieutenant, took charge. But more often, it's like Magellan Fund after the retirement of the great Peter Lynch in 1990: No one else has had the same success.

An important exception to this rule applies to funds run by a team or committee. For instance, the departure of one team member on a Dodge & Cox or American fund is less disruptive than a sole star manager stepping down.

Be wary if a fund family tells you a manager change makes no difference. Chances are the company originally sold the fund on the merits of the ace manager. They can't have it both ways.

Change in style

We'll divide this into two parts: the manager's style and your style.

In the first case, say you invested in a fund that bought midsize-company stocks, but the manager began drifting into large companies as his fund increased in size. That's exactly what happened with Calamos Growth. Or maybe you put money with a manager who claimed to be a patient value guy, but he began chasing frothy growth stocks and turning the portfolio over 100% a year. Those could be reasons to cut and run.

In the other case, you change. Perhaps your fund helped you reach your financial goals, but now you're approaching retirement. That aggressive-growth fund in your 401(k) no longer makes sense for you. You may want to shift to a more conservative fund that focuses on capital preservation and income.

Asset bloat

Too much money in a fund "is the enemy of great returns," asserts Steve Rogé, a financial adviser and manager of Rogé Partners. This is particularly true for small- and midsize-company funds. Because small-company stocks tend to be harder to buy and sell in large quantities, bloated funds may actually raise and lower small-company-stock prices as they buy and sell shares. That makes trading expensive. Super-heavyweight large-company funds could take a week or more to build or exit a stock position.

Rogé thinks small-company funds should close to new investors before their assets reach $1 billion. He says to be on the lookout for overweight small-company funds that start diversifying too much -- moving from 30 stock holdings in the portfolio to 100 stocks, for example. You want a manager's best investment ideas, not his marginal ones.

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