Avoiding a Hot Fund Before It Closes

Contributed by mm | April 12, 2006 11:26 AM PST

Should you get in before Fidelity Contrafund closes its door on April 28th? History says no.

A closure is often a tip-off that the fund has already reached an unwieldy size, and that the manager is having difficulty taking positions in attractive stocks that are large enough to improve performance, says Russel Kinnel, director of mutual-fund research at the Chicago fund-tracking firm Morningstar Inc.

...

In a study a few years ago, Morningstar found that after hot mutual funds close, their performance versus similar funds -- that is, those with comparable investment objectives -- declines. Looking at 38 funds that closed, Morningstar found that the closers, on average, beat 80% of their peers in the three years prior to closing. Afterward, they fell behind more than half of their peers. Overall total return slipped to 15.4% a year from 19.6%.

The study didn't provide average returns versus benchmarks -- investment indexes that matched the kinds of stock the closing funds invested in. But Mr. Kinnel said the funds were typically trouncing their benchmarks prior to closing, and after closing, many were often hovering closer to their benchmarks.

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