Equity mutual funds most used by defined contribution plans may be victims of their own popularity.
In fact, Fidelity's move to close three more funds to retail investment means four of the 10 stock funds most popular with defined contribution plans are essentially 401(k)-plan-only funds.
They are: the $64 billion Magellan Fund, ranked as the most used fund; the $41 billion Fidelity Growth & Income Fund, ranked second; the $32 billion Fidelity Contrafund, ranked fifth; and the $21 billion Vanguard/Windsor I Fund, ranked seventh.
Fidelity closed Magellan last year and, next month, will close Growth & Income, Contrafund and its Low-Priced Stock Fund (which ranks as the 28th most-used fund by defined contribution plans). Vanguard most recently closed Windsor I in 1989.
Defined contribution plan assets made up almost half the total assets of Growth & Income, about 42% of Contrafund and a little more than 25% of Low-Priced Stock as of Dec. 31, according to data from Pensions & Investments' survey of mutual funds most used by defined contribution plans. About 47% of Windsor I's assets are from defined contribution plan investors.
Meanwhile, total assets and defined contribution assets in the 10 funds most used by defined contribution plans increased more than 500% during the past five years. Total assets of the 10 grew to almost $290 billion; defined contribution assets in those funds increased to almost $140 billion.
But performance hasn't always kept pace with stellar asset growth.
Growth & Income
Only one of the 10 most popular stock funds outperformed the 20.27% annualized return of the Standard & Poor's 500 stock index for the five years ended Dec. 31 -- and did so by only a fraction.
That's Fidelity Growth & Income, which returned 20.9% for the period. The $21.2 billion Fidelity Equity Income I Fund matched the S&P 500, with a 20.3% return. It is ranked fourth among the most-used funds.
Steven Kaye, portfolio manager for Fidelity Growth & Income, said that even though huge cash inflows -- $2 billion in the first two months of 1998 -- haven't cramped his large-capitalization investment approach, closing the fund is "a forward-looking action. We are trying to position the fund for the long term."
The Growth & Income Fund had the greatest growth in defined contribution plan assets of all stock funds in P&I's survey of the mutual funds most used by defined contribution plans. The fund added $6.475 billion in defined contribution assets during the year ended Dec. 31. The fund's defined contribution assets totaled $17.872 billion as of Dec. 31.
Mr. Kaye took over the fund in January 1993, when it had just $5 billion in assets.
The Contrafund now is known as Contrafund I, since a clone fund, Contrafund II, will be opened April 1. Contrafund I moved down to fifth place from third in P&I's ranking, with $13.065 billion managed for defined contribution plan investors as of Dec. 31. It gained about $3.6 billion in new defined contribution assets last year.
Will Danoff, the fund's manager, said controlling cash flow will help him maintain his midcap investment style. He denied that the weaker performance of Contrafund over the past year was caused by the fund's size, which increased 1,461% in five years. The fund's return for the year ended Dec. 31 was 23%, compared with 33.36% for the S&P 500.
Mr. Danoff attributed performance problems to the explosion of higher price-earnings ratios of the top 50 stocks in the S&P 500, which hurt midcap stocks.
The move to restrict access to those three funds "made defined contribution plan clients very happy and left prospects disappointed," said Peter J. Smail, president of Fidelity Institutional Retirement Services Co., Boston.
Robert C. Pozen, president of Fidelity Management & Research Co., told reporters the move to close funds was made jointly with fund managers so that they could more efficiently manage their funds.
"It has been the rate of new cash flow that has concerned us," he said. "We think partially closing the funds will have a significant impact on the management of the funds. These managers will still have some cash flow to manage, but it will be much less."
Closing Magellan last year was "a big success," Mr. Pozen said. Stabilizing fund inflows has enabled the megafund's manager, Robert Stansky, to outperform both peer funds and market indexes.
Getting some credit
"I think we should get some credit here for closing a best-selling fund at its peak," Mr. Pozen said.
Scott Lummer, chief investment officer of the consulting firm The 401(k) Forum, San Francisco, was willing to give Mr. Pozen credit for closing Growth & Income. But he said, "I think they should have done it at least a year earlier. Constant buckets of money coming in are a nice problem to have, but when a fund gets so big, it becomes hard to differentiate it from the index."
"Mutual fund size should always be an issue," agreed Robin Pellish, a managing director at consultants RogersCasey, Darien, Conn. "I can't imagine that anyone can deny that there's a limited number of good ideas fund managers can come up with. And once you have to start diluting those good ideas because you have too much cash to invest, you start to erode the value-added, the outperformance that managers are seeking to add on top of the market index return."
Defined contribution plan sponsors have had a tendency to choose as options the name-brand mutual funds. Such choices, they believe, encourage participation, even when performance begins to droop, Ms. Pellish said.
She noted that executives of defined benefit plans pressure money managers to close when they get too big, or they fire them when they violate their stated investment approaches. With mutual funds, however, there's a "tradeoff" between name recognition and "what might be missing in returns and style consistency," Ms. Pellish said.
Most observers agreed defined contribution plan investors help mutual funds stabilize their cash flows, making portfolio managers' job easier.
"It's very difficult to study the impact of a lot of defined contribution plan money in a mutual fund and the effect of steady, on-going monthly contributions to a manager's style," said David Masters, a consultant at mutual fund trackers, Micropal Inc., Boston.
"But I think you can say that stabilized inflows do have a psychological impact on fund management. if you know you have X amount of stable money flowing in and you know it will be around for a while, you can take more risks. . . . Steady cash flow can have a liberating influence . . ."
Roland Gillis, comanager of the $19 billion Putnam Voyager Fund, agreed. (About 44% of the Voyager Fund's assets as of Dec. 31 were managed for defined contribution plan investors.)
Mr. Gillis said surging and unpredictable cash flow became such a problem for the fund that three years ago Putnam Investments, Boston, divided Voyager's management in three. Mr. Gillis manages the small-cap portion; Bob Beck, large-cap; and Charles Swanberg, midcap.
Voyager's large size, however, has enabled Putnam to commit a far larger research effort and more analysts to the fund and the company's specialty growth group in general, Mr. Gillis noted.
The Vanguard Group of Investment Cos., Malvern, Pa., has coped with the tendency for large funds to have less flexibility and flatter returns by increasing the number of outside managers managing portions of some of its funds.
"Capacity issues are magnified in small-company funds because capacity is so quickly absorbed," said Jeffrey Molitar, director of portfolio review. Last year, Vanguard added two new advisers to the management of its Explorer Fund, when it "seemed that a single manager had just a bit too much cash. We didn't consider closing the fund, but we saw that by adding managers, we could cope with the potential problem."