If you've been meaning to become an investor in the Vanguard Health Care Fund
Still, if you're wondering why a fund would close its doors, permit me to explain. It's actually an admirable thing for a fund to do. Imagine that you're at the helm of a mutual fund, and you're doing well. You're finding compelling investments and are generating a solid return for your shareholders. They proudly display your photo on their mantels, pianos, and refrigerators. You're also enjoying some income yourself, via the management fees levied by the fund. (These often top 1%. If your fund holds $1 billion, 1% amounts to a rather significant $10 million.) Meanwhile, your fund is occasionally mentioned in the press as a good performer. In response, new shareholders are signing up regularly, delivering more and more dollars for you to invest. You (and/or other decision makers at your firm) have some options:
- You can keep on doing what you're doing, letting the fund grow. The upside is a growing take from fees for you and the company. The downside is that it will be harder and harder for you to find enough compelling investments. You'll likely have to put more money in second-tier or third-tier securities. Your 177th- and 178th-best ideas are not likely to perform as well as your top and second-best ideas.
- You can go for the big bucks, advertising your firm more, and trying to get in the news. As deposits swell, so will your revenues.
- You can restrict inflows to the fund by, among other things, closing it to new investors. (Some funds restrict inflows by setting high minimum initial investment amounts -- the Vanguard fund in question actually already had a $25,000 minimum.) The upside of restriction is that you'll make it easier for yourself to find investment bargains and continue your solid performance. The downside is that you're limiting your fee intake (unless you raise your fees, of course).
Given the above options, it's clear that the best way to serve current shareholders is to limit cash inflows and keep the fund at a manageable size. Yet relatively few funds do so.
The Vanguard Health Care Fund closed to new investors before, in 1999, for 10 months. In a MarketWatch article, Jonathan Burton noted, "Investors who bought in afterward have been rewarded, and not just with the fund's rock-bottom annual expenses of 0.28.... Over the past five years through March 22, Vanguard Health Care rose 9.7% annually on average, landing it in the top 15% of health-care sector funds, according to investment-research firm Morningstar. The no-load fund's 8.7% gain over the past 12 months tops 94% of its peers." Its top 10 holdings, as of Dec. 31, 2004, included Pfizer
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Learn much more in these articles:
- The Case for Mutual Funds
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- You're Paying How Much?
- Champion Funds Still Beating the Market
Longtime Fool contributor Selena Maranjian owns shares of Pfizer.
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