Take the back door into closed funds

By Tim Middleton

No impulse is more human than wanting what you can't have. For mutual fund investors, that's a mouth-watering fund that's closed to new investors.

The closure of a mutual fund arouses such animal lust that, increasingly, funds are being closed without warning, since advance notice usually spurs a last-minute flood of assets. Earlier this month, Wasatch Funds closed its new International Opportunity Fund before it even opened, two days into a two-week subscription period.

But there are back doors into closed funds, and other strategies for satisfying your urge to belong to a club that doesn't want you as a member. Many funds closed to ordinary investors are open to participants in corporate 401(k) plans. Many managers run open funds at the same time their flagship is closed. Almost invariably, a near-clone is available.

The most common way to get into a great closed fund is to buy it long before it closes. But the traits that top closed funds exhibit -- superb performance, backed by economical administration and managers who have their money in the same pot as yours -- are shared by many others still open.

Indeed, rushing into a fund you've never heard of just because it's going to close is apt to be a mistake. As I've observed several times in this space, closing could be a sign of an overheated marketplace set to collapse.

Some of the best

A mere 3.4% of the nation's mutual funds are closed to new investors, but they include the creme de la creme: Vanguard Primecap (VPMCX), up 18.3% last year; Fidelity Low-Priced Stock (FLPSX), up 22.2%; RS Partners (RSPFX), ahead 31.8%; and Acadian Emerging Markets (AEMGX), up 33.5%.

Funds typically close because they're on the verge of becoming too big to handle. An example from last year is Dodge & Cox Stock (DODGX), whose assets doubled to $29.44 billion in 2003 and were on their way to doubling again in 2004. The fund had been splendid in the 1990s, when everything was up. But it became increasingly attractive in the bear market as it continued to rack up profits while others were melting down in 2000 and 2001.

The problem with too many assets is that managers typically make their names as stock pickers, and there are only so many outperforming stocks they can pick. The problem is most acute at small-company funds, and indeed nearly a third of all closed funds are small-cap portfolios.

So the advantage of being closed is that the asset avalanche ends, allowing managers to focus on their best ideas. Now the whole idea is to keep you out. But that doesn't always work. Here's how to join the 'in' crowd:

Find clones of closed funds

If you're disappointed that Vanguard closed Primecap, for example, take a look at Primecap Odyssey Growth (POGRX), which is run by the same staff in a similar style. Vanguard was more worried about asset bloat than Primecap Management, which actually invests the money. So Primecap started its own alternative.

It's not uncommon for managers to clone funds they close, using a variant of their original strategy in the new portfolio. Last year, I wrote about Bridgeway Aggressive Investors 2 (BRAIX), which actually performed better last year than the original aggressive fund.

Hennessy Cornerstone Growth (HFCGX) is still open, but with nearly $1 billion in assets, the small-cap portfolio is approaching what manager Neil Hennessy views as his limit. If he closes it, which he says could come when assets hit $1.3 billion or so, he plans to offer a clone that uses the same momentum-based strategy but invests on a different time cycle than the original.

Find a near-match

"If I cannot find the same manager, can I find the same management style (at a fund) that may be less recognized?" says Dan Wiener, editor of the Independent Adviser for Vanguard Investors newsletter.

When Vanguard International Explorer (VINEX) closed, Wiener began recommending Fidelity International Small Cap (FISMX), a relatively new fund with a similar mandate that's posting extraordinary results.

Screening tools such as those of MSN Money's Deluxe Fund Screener make it possible to sort the universe of open funds for those with characteristics similar to a coveted closed fund. This is, once again, most difficult in the small-cap universe, because so many of the good ones are closed, but much easier for funds that invest in bigger marketplaces.

Find a back door

Retirement plans like 401(k)s that offer a variety of funds from different companies will sometimes include a closed fund because of its cachet.

Funds like Fidelity Magellan (FMAGX) allow retirement investors in, while keeping others out, because their contributions are more predictable and much less likely to be pulled during a market flutter.

Find tomorrow's private club

I happen to own a bunch of closed funds, and in most instances that's because I bought them long ago, when they were merely the best ones I could find.

For example, in researching this column I discovered that two funds I own, T. Rowe Price Mid-Cap Growth (RPMGX) and T. Rowe Price Small-Cap Stock (OTCFX), were closed, but I didn't know it. I've owned them for years.

Great funds are characterized by performance that's consistent as well as superior; by management that adheres to a sensible discipline rigorously, without regard for whether it's popular at the moment or not; by expenses that are economical, so the manager doesn't have to assume undue risk to generate excess returns he consumes with fees; and, ideally, by managers who invest in their funds.

The search for great funds will usually begin at great fund companies, and more often than not they will be no-load fund companies. Of the 10 largest funds, five are load funds, and they're all open.

Of the other five, one is an index fund -- and index funds by their nature seldom close --and three, all of them no-loads, are closed. The only giant no-load still open is Fidelity Contrafund (FCNTX), which invests (very well) in the largest, most-liquid stocks.

Use with care

The risk of allowing the word "closed" to conjure up visions of wealth is that the universe of closed funds contains its share of failures. Sometimes they're temporary. In 1999, Vanguard Health Care (VGHCX) was closed during what turned out to be a lousy year, only to surge more than 60% a year later, when it reopened.

Something similar happened early in the aughts when T. Rowe Price International Discovery (PRIDX) was closed just ahead of dismal performance, only to reopen in time to capture a 65% gain in 2003.

But sometimes the problems are permanent. The poster child for funds that close too late is Fidelity Magellan, which became legendary when it was small and then less than mediocre when it became a behemoth during the 1990s.

So the prize isn't exclusivity, it's performance.

If you invest wisely, chances are you will find yourself a member of next decade's most exclusive club, as the funds you choose now close behind you.

At the time of publication, Timothy Middleton owned the following securities mentioned in this article: Wasatch International Opportunities, Acadian Emerging Markets, T. Rowe Price Mid-Cap Growth, T. Rowe Price Small Stock, T. Rowe Price International Discovery and Dodge & Cox Stock.