When you own individual stocks and bonds, you don’t have to pay too much attention to what your fellow shareholders (or bond holders) are doing.
A mutual fund is a little different, though, because the actions of your fellow shareholders can affect your returns, especially on an after-tax basis.
Morningstar reported last week that of their 500 most widely followed mutual funds, 168 have seen outflows of more than 10 percent, 61 more have endured withdrawals of 25 percent and 18 have seen assets drop 40 percent in the last 12 months.
They published a list of the funds with the largest withdrawals and some of them are pretty remarkable. The Manning & Napier Equity fund had $955 million under management a year ago, and thanks to client withdrawals, they now manage $204 million in this fund.
The largest fund on the list, the PIMCO All Asset Authority fund has been managing $18.9 billion but is now down to $10.6 billion one year later as clients pulled money out. There well known fund managers including Dreyfus, Columbia, Royce, Artisan and FPA.
We don’t invest in any of the funds on the list, but we do keep an eye on what’s happening to the assets under management with our mutual funds because when your fellow shareholders start liquidating, it can create problems for you.
Dimensional Fund Advisors (DFA) doesn’t allow individual investors to buy their funds without an advisor explicitly because they don’t want a lot of hot money coming into and out of funds based on short-term performance.
DFA argues that co-mingled products like mutual funds aren’t a problem as long as the shareholders behave, which they control in part by determining who can and can’t become a fund holder.
When your fellow shareholders start wholesale selling, it can put pressure on the holdings in the fund, particularly in less efficient markets like microchip stocks or international small cap value stocks.
While large cap funds are probably immune from this particular problem, your fellow shareholders can create a tax bill for you because the fund manager may have to liquidate assets with capital gains that will be distributed to remaining shareholders.
This potential tax problem can be avoided by using exchange traded funds (ETFs), which we use extensively. Both of the mutual fund companies that we use, DFA and AQR, limit who can become share-holders, which we think mitigates the problem substantially.
Still, we pay attention to what our fellow shareholders are doing in an effort to make sure that their actions don’t adversely affect your results.