Are Bigger Funds Always Better?

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I thought this was a highly informative and balanced article on the issue of mutual fund size.

LINK

[jIM_Ohio]

NO- size does matter. In more ways than one.

For small caps (and micro caps) in particular, there are only so many good companies to invest in (there might be 4500+ companies in wilshire 4500 index, but only a handful are worth investing in).

So any fund manager working to stay in the small cap space is best advised to make sure they only get enough money coming in to fund their good ideas. If a fund manager gets too much money, they start funding their bad ideas too.

There are rules (SEC rules) which suggest a given mutual fund can only own a given % of a companies stock (maybe 5%??). Meaning if the fund too a big stake in a small company (fund owns 5%), they cannot buy more of this good idea if they had more money- they would need to buy something else with more money.

I believe Fidelity Magellan/Peter Lynch started as a small cap fund.

For large cap funds, the probability that a manager would run out of ideas is a weaker argument, because there are only 500 or so companies to even consider in this world. And trying to own 5% of Microsoft or GE s nearly impossible (companies are worth too much money for any one entity to probably own more than .5% of the outstanding stock). The issue is whether Microsoft or GE is a good investment for a large cap manager- is the manager willing to increase funds stake from 2% to 2.5% of this company, and at what valuation will they add this position?

There are some managers which just buy those large companies at any price. Those funds are also closet index funds- because the index funds have to do the same thing. There are other funds which only buy these stocks on dips, or are willing to buy a mid cap hoping it becomes large- maybe a smaller stake in a mid cap relative to whole portfolio, but a move to help make the fund money.

I opened my PRFDX account in 1999 I believe. It is a large value fund. The first thing the fund manager did when the market crashed (according to prospectus) was to add large growth companies (MSFT, ORCL) to the fund. Both fund exhibited most traits of the fund holdings (solid financials, P/E etc...) except the dividend piece. 2 years later MSFT paid a dividend and has been increasing it ever since.

So PRFDX could get bigger (IMO) without draining performance. But many other funds would probably drag performance if they got bigger (like T Rowe Blue Chip Growth, for example).

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So I take it you agree with the article then.

[jIM_Ohio]

I thought the title of the thread (bigger funds better) contradicted the article.

Insert pet peeve on thread titles here.

[pfodyssey]

I've heard these arguments before...and there is some validity. For better or worse, I rely on the fund to monitor its own size and figure out whether or not they should close the fund to stop the inflows. I own several of these types of funds (closed ones) through T Rowe Price, so I feel comfortable they are paying attention.

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To some extent, I think there's something to be said about brokerages that will close their funds to mitigate this issue, and ones that won't but insist that they have Everything Under Control. Ahem.