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By Russel Kinnel and Christine Benz | 07-19-2017 12:00 AM

A Watchlist of Interesting Closed Funds

These three closed funds are experiencing modest outflows and could reopen, says Morningstar's Russ Kinnel.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. As asset flows out of active funds have continued to pick up, some high-quality closed funds may reopen. Joining me to share a watchlist of closed funds is Russ Kinnel. He is director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Happy to be here.

Benz: In the latest issue of Morningstar FundInvestor, you took a look at funds that have seen heavy redemptions of late over the past few years. And you compiled kind of a closed fund watchlist, good funds that you think, if redemptions continue, may in fact reopen at a later date. Let's talk about kind of the thesis behind looking at funds that have recently reopened or that might reopen.

Kinnel: If you think about it, if you buy a fund just before it closes, you're kind of buying into a hot asset class that's probably already had a great run. Then you're talking about the flip side when you look at a fund reopening, usually that means its asset class or its strategy is unpopular. Obviously, equities themselves have had a great run, but you can see that each of these funds has at least had a bit of a slump and therefore, as a contrarian, it tells me maybe this is a good time to get in provided they actually do reopen.

Benz: OK. So, is there a risk if you are looking at a fund like this or a fund that's seen really heavy redemptions, is there any risk that the fund could get caught in kind of a death spiral where the manager is having to sell everything in the portfolio to meet redemptions? Can that result in bad performance sometimes?

Kinnel: It certainly can, and we're really watching flows these days closely because as you know, so many active funds are being redeemed.

Benz: Right.

Kinnel: So, yeah, I think you do want to watch that closely. The funds I've picked are having modest outflows rather than a disastrous run. But we do see sometimes, that flows can be self-fulfilling in both directions and occasionally, they can really hurt a fund when there's big outflows.

Benz: Is that a particular problem if the fund invests in some sort of illiquid asset class or something like that?

Kinnel: That's right. So, small caps, micro caps, bank loans, high yield--those are areas where we really worry. If it's, say, large-cap or high-quality bonds, it's rarely a problem.

Benz: OK. So, you brought a few different ideas, funds that are closed, we want to confirm that, but funds that you think could be interesting if they reopened. Top of the list is Diamond Hill Small Cap. Let's talk about why small-cap strategies tend to close more frequently than large caps. And then let's stock specifically about the attributes of this fund and why you like it.

Kinnel: Yeah. So, small caps tend to have real liquidity constraints, and so, just because there's only so much you can buy. If you want to keep a small-cap fund open after a certain point, that means you either have to buy a lot more stocks or move up in market cap. Either way, you are deviating from the strategy that worked in the first place. So, small-cap funds will often close before letting the assets overwhelm the strategy.

Benz: OK. And then Diamond Hill Small Cap, in particular--I know that we have liked some of Diamond Hill's other products as well, sort of a value specialist as a firm?

Kinnel: That's right. We really like just about everything Diamond Hill does because they are just very good value investors. They run relatively focused portfolios looking for names that are trading below their intrinsic value, and they are pretty patient about waiting for them to come back. In this particular case, this is a fund we rate Silver, actually now its outflows have taken it a little bit below where it closed the previous time. So, I wouldn't be surprised to see it reopen. But it's just a really strong small-cap value fund that I think has a lot of appeal and is worth keeping an eye on if it does reopen.

Benz: OK. On the other edge of the style box, Wasatch Small Cap Growth, Wasatch is a small-cap specialist. Let's talk about why you would have this fund on your radar, why you think it's a good pick for investors who may, at some point, be able to buy it.

Kinnel: Yeah. The fund has had about $460 million in outflows the last year. So, I wouldn't be at all surprised to see it reopen. JB Taylor took the helm of this fund about a year ago. Normally, new managers don't get Gold ratings like this one, but he has got a very good record at another fund and so we really have faith in his ability to execute this strategy, which is really looking for steady growers with good earnings that can continue to deliver. And so, I think it's a really appealing fund. Wasatch has a great record of closing funds before they get too big. So, that's another reason I like their funds.

Benz: OK. Last fund on your closed fund watchlist is also a small-cap specialist but an international fund, this is Artisan International Small Cap. Let's talk about why you think that's an interesting one to keep on your radar.

Kinnel: Yeah. It's had about $300 million in outflows, and it's down to just about $550 million in assets total. So, I wouldn't be surprised to see it reopen. It's had a bad run, but Mark Yockey is the manager. He has won our Manager of the Year award in the past and historically, he has done a very good job with sort of a growth-at-a-reasonable-rice strategy. So, I think, this is a really good fund that--I talked about Wasatch closing early – this historically closed pretty early. So, I would find it pretty appealing because a good foreign small-cap fund that's open is hard to find. So, if this does reopen, I'll be really interested.

Benz: OK. Russ, interesting watchlist. Thank you so much for being here to discuss it with us.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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