The clock is ticking. By the end of the month, Fidelity will close its popular Contrafund
However, the pending closure doesn't mean you should rush to get your foot in the door. If anything, closing the fund is an admission that it was approaching unmanageable levels.
According to Morningstar, the fund has beaten the S&P 500 in only six of the past 10 years, but when it has come out ahead, it has done so with aplomb. Over the past three years, Contrafund has produced 22.3% in average annualized returns. It has also handily trounced the market over the past five and 10 years.
Big return, big fund, big problem
Mutual funds don't grow their asset bases by accident. Performance draws a crowd. But that creates a situation where the investing strategy that helped achieve stellar results is compromised by the need to buy larger and larger companies.
Contrafund earned its stripes zigging when the rest of the market was zagging, but now the contrarian fund is loaded with market-cap giants such as ExxonMobil
Yes, these are quality stocks, but when you're a money manager with $64 billion to juggle around, it gets awfully stifling when you see your universe of buyable stocks contracting.
The situation gets more critical with micro-cap and small-cap funds that specialize in companies with thin market caps. They are forced to close earlier in their tenure. It can happen in a hurry, too, when a fund in this small-fry niche has a blowout year that will catapult it out of obscurity and into the realm of massive inflows.
As much as I appreciate a mutual fund operator forgoing the near-term easy money of keeping a cumbersome vehicle open, I still can't help seeing a shutdown as a warning sign.
It's not as if bigger is any better in terms of economies of scale. As big as Contrafund is, shareowners are still hit with a 0.92% expense ratio. That would be a reasonable percentage for a nimble fund, but I don't know whether I would want to pay three to four times the management fees that I would on a low-cost index fund to buy into a bloated fund with the grace of a greased elephant.
One way around the road block
Earlier this year, I wrote on the merit of buying closed-end funds at a discount. Unlike conventional mutual funds, closed-end funds have a fixed number of shares and trade on the market. That sometimes opens up the possibilities for attractive funds trading for less than the value of their portfolios.
More to this particular point, here's one of the reasons I argued in favor of considering closed-end funds:
Because a closed-end fund has a fixed number of shares, managers are not distracted by the perpetual inflows and outflows of capital. That allows them to stick to their investing strategy without having to hoard away too much cash or sell stocks earlier than they would have liked in order to cope with the influx of new capital or the outflow of redemptions.
Even some of the proven fund managers that Shannon Zimmerman has recommended to Motley Fool Champion Funds subscribers -- like deep-value buff Charles Royce -- run closed-end funds. Because the only way to buy shares is off someone looking to sell theirs, trading in closed-end funds is never a burden to the fund managers.
The Royce-managed fund that Shannon singled out ultimately closed to new investors earlier this year. That will never happen to the three Royce closed-end funds that you can acquire in the open market.
You don't have to worry about the sign being flipped to "closed." If you happen to buy into a hot closed-end fund, a winning streak doesn't sandbag future performance with an influx of idle cash. Even better, it may turn a fund trading at a discount into one trading at a premium, thus allowing you to leverage your good fortune.
Everything counts in large amounts
So what if you don't want to buy closed-end funds or exchange-traded funds? If you prefer conventional mutual funds, just know what you're buying into. Make sure that you aren't just buying into last year's performance and a low expense ratio. Get to know the manager's track record and the fund's ability to handle the load.
Even though buying mutual funds is easy, buying them right isn't that simple. That's why Shannon launched the Champion Funds newsletter service two years ago. Every month, he uncovers promising investment vehicles, then tracks his picks perpetually to make sure that a proven performer doesn't get all gangly and sloppy on you.
If you want to learn more about Shannon's mutual fund investing style, you can subscribe to his service or hold back with a 30-day trial subscription offer to make sure it's right for you. Yes, those 30 days will take you just past the Contrafund closing deadline. I reckon it will be time better spent than trying to get your foot stuck in Fidelity's door.
At least with that particular fund at this juncture.
3M is a Motley Fool Inside Value pick.
Longtime Fool contributor Rick Munarriz has invested in closed-end funds in the past, though he does not own any at the moment. T he Fool has a disclosure policy. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.
