4 Signs It's Time to Dump Your Mutual Fund

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mutual fund performanceIt isn't easy to manage a $17 billion mutual fund these days. No one knows that better than Harry Lange, who was just booted from the helm at Fidelity Magellan (FMAGX), the iconic mutual fund that Peter Lynch put on the map.

The Harvard MBA's tenure had been disappointing since he took over the fund in late 2005. It has truly been a lost decade for the rock star fund that had roughly $100 billion in assets before the tech bubble burst. According to Morningstar, Fidelity Magellan has underperformed 96% of the funds in its large growth category over the past five years.

Investors probably should have seen this coming. But many didn't.

My Fund Did What?!

Many Magellan shareowners may not even realize how poorly the fund has been doing lately. After all, actively managed mutual funds are attractive to investors that don't want to keep up with the market's daily gyrations. However, ownership can't be an entirely passive experience.

Even if you only check your fund's Net Asset Value every once in a while, there are four signs to watch for that should find you evaluating if you still want to be an investor in that particular fund.

1. There's a new fund manager
If you were drawn to the Fidelity Magellan fund by Lynch's performance, or after reading his intuitive books, you're 21 years too late. Taking Lange's place is Jeffrey Feingold, who will become the fifth manager of Fidelity Magellan since Lynch left in 1990.

It doesn't matter that there once was an investing legend at the helm. Whenever there's a change at the top, you can't assume the investing philosophy that attracted you to the fund will remain intact. Every manager that has taken the reins has reshaped the fund's portfolio to match his unique style. A fund's category won't change, but the thinking on buy and sell decisions probably will.

There are two reasons -- except retirement -- behind any change at the helm. If the manager is doing too well, she may be whisked away by a rival firm or decide to strike out on her own. If the manager is doing poorly, we don't need to ask why the baton is being handed to someone else. In either case, investors need to reassess their reasons for ownership.

Feingold may very well do a better job than Lange. It will be hard to do worse. However, this is still a defining moment for the fund and its shareowners.

2. The asset base is getting too big
It gets hard for a large fund to be successful, since the bigger it gets the more limited it is in the stocks that it can buy or sell without moving the market. Lynch was smart enough to go out on top.

For those scoring at home, Fidelity Magellan at $100 billion in 2000 -- 10 years after Lynch's retirement -- was too big. Even the fund's net assets of $17 billion today may be too unwieldy to effectively manage. Lange probably would have done a much better job with a smaller fund.

It's true that a fund's growth is typically tied to its performance. A market-beating vehicle will attract a healthy inflow of new money. However, there's also a reason some funds close to new cash when they get to a certain size, especially funds that specialize in small- or mid-cap companies.

This rule obviously doesn't apply to index funds, where it's the same basket of stocks being bought and sold.

3. The asset base is getting too small
I hate to get all Goldilocks on you, but too small can be just as problematic as too big. A shrinking asset base indicates either that a fund is losing money or that more investors are selling than buying. Most likely, it's a combination of the two.

The problem with this situation is that a manager often has to sell fund holdings -- often at the most inopportune time and with taxable implications -- to cash out investors requesting redemptions. You don't want to be the one left holding the bag.

4. Your fund is being merged into another fund
There are many reasons why a fund family might combine two of its funds:

  • A small offering may not be as cost-effective to maintain as the fund operator initially expected.
  • Investor interest just isn't there for the fund being absorbed.
  • There's a merger between two fund families.

However, by far the sneakiest tactic -- and a common one, too -- is to bury a fund's poor performance by merging it with one that has amassed a better track record.

This can be a problem to investors in both funds. Even if there isn't a culture clash in management styles or if the acquired holdings aren't being sold right away, the transition can be rocky. Some investors in the fund being acquired will be tempted to cash out, especially if the new fund has a much different objective than the one that they originally bought into.

Know Your Funds

There are plenty of other fundamental reasons for investors to bail on a fund. Management fees may be too high. Its asset allocations or investing strategy may not be right for you or for current market conditions.

Underperformance for short stretches is fine. No manager is perfect. However, routinely losing out to its peers is unforgivable in a world of plentiful alternatives.

It's your money. Do Lynch proud and take an interest in how it's being managed.

Longtime Motley Fool contributor Rick Munarriz does not own shares in Fidelity Magellan.



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