Every now and then when I go to make a trade for a client the mutual fund I recommended will be closed to new investors. This recently happened when I tried to make trades in an account we had just set up for a new client.
When I told him the fund I recommended was closed he asked the logical question: “How come?”
Why do good funds close to new investors? It seems counter-intuitive. Aren’t they in the business of taking in assets and managing money? Why would they turn down an opportunity for new business?
By their very nature, mutual funds are diversified portfolios of various securities – primarily stocks and bonds. Also known as “investment companies” they must comply with the Investment Company Act of 1940 which limits their holdings of any one stock to no more than 5% of the mutual fund’s assets.
As mutual funds get new cash inflows the fund manager invests those dollars into their favorite stocks. When a fund does well and becomes popular word gets out. Cash inflows increase. And fund managers are forced to start buying stocks from their second, third, and fourth round picks.
To control the flow of new money coming in and ultimately to protect current shareholders of the fund, a mutual fund may close. That way they don’t water down their portfolio in an effort to invest the torrent of new cash coming in.
Small cap stock funds, concentrated funds that own only a few select stocks, and specialty funds that focus on a particular investment style or niche are more likely to close than a large cap stock fund with billions in assets.
If your favorite fund does close, all is not lost. Mutual fund closures can be what is known as a “hard close” in which absolutely no new money is allowed in. Or, more often, a “soft close” where existing fund shareholders are permitted to continue to buy more shares, but the mutual fund remains closed to those who don’t already own shares of that fund.
Typically this is done on a “per account basis”. So while you may be able to add to a closed fund that you own in your IRA, you may not be able to do so in your Roth IRA unless you already own that fund in that particular account.
Eventually your chosen fund may open its doors again to new investors. Even if your fund walls itself off forever, there is almost always another comparable fund that will welcome you with open arms.
Investing in mutual funds involves risk, including the potential loss of principal invested. Risks vary depending upon the strategy used by the fund as well as the sectors in which the fund invest. When redeemed, shares may be worth more or less than the original amount invested.