Bigger funds aren't always better, but it's not that bad
— -- Bigger isn't always better, as anyone who has popped a balloon behind a grizzly bear can tell you. And it's long been noted that bigger isn't particularly better for stock mutual funds, either: Gargantuan funds are less nimble than smaller funds.
So which funds are the most popular offerings in 401(k) plans? The biggest ones, of course. For many investors, big funds are the only choice they get. As it turns out, however, that's not the worst thing in the world.
The argument against large funds is this: A large fund has to take enormous positions, and those positions can take time to get into and out of. For example, the American Funds Growth Fund of America is the largest actively managed stock fund in the U.S., weighing in at $137 billion. The fund's largest holding is Apple: It owns about 11.6 million shares, according to Morningstar.
The fund isn't gorging itself on Apple, which is just 2.6% of its portfolio. Nevertheless, 11.6 million shares is a big position. If the fund buys or sells it all at once, it would move the price unfavorably; an average 20 million shares of Apple trade per day.
Size can also mean that a fund can't get enough of a small or midsize stock that it wants. Most funds can use Apple as a core holding, because there are plenty of Apple shares to peel off. But let's say that Growth Fund of America were interested in Mindray Medical, a Chinese health care company with a mildly creepy name.
The company has 85.5 million shares outstanding and a market value of $2.1 billion. Putting 2% of the Growth Fund of America into Mindray would mean buying the entire company, with change left over. Funds don't do that. If the fund bought 5% of Mindray's stock — a large portion by most funds' standards — the position would be so small as to be virtually meaningless.
Why do funds get so big? In most cases, because they are successful. Growth Fund of America, for example, beat 82% of its peers the past 10 years.
And, from a mutual fund company's perspective, a large fund is swell. Fund management makes money by taking a portion of the fund's assets. The bigger the fund, the more money for the manager, particularly since a fund that doubles in size doesn't cost twice as much to manage.
For example, Fidelity Contrafund pays a 0.72% management fee. The fund has $52.4 billion in assets, so the gross annual fee to Fidelity would be roughly $377 million.
Retirement plan administrators like big funds because they, too, like funds that perform well. And big funds often come from big fund companies, which offer lots of administrative help in running the plans.
The upshot, however, is that investors usually have to pick from among a handful of large stock funds. Is that bad? It depends.
Suppose you had invested $100 a month, or $24,000 total, in the Standard & Poor's 500-stock index the past 20 years. You'd have $41,096 today. Half of the 10 largest funds two decades ago beat the S&P 500; half lagged. Worst performer: Pioneer Value, which turned your monthly investment to $29,000. Best: Fidelity Puritan, which turned $100 a month into $46,832. The largest fund of the day, Fidelity Magellan, came in a dismal ninth.
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