Should you stick it out?
By Karen Dolan, CFA | 06-30-08 | 06:00 AM | Email Article

Outflows are typically a nuisance for fund managers who have to sell more than they are buying, but they can become a destructive force when trading volume for the fund's holdings dries up. In that case, selling can actually lead to worse losses as the fund's traders have to offer fire-sale prices in order to find a buyer. In the last 12 months we've seen a sharp increase in cases of destructive redemptions that have turned poor market returns into awful losses. The following four funds have seen a huge pickup in outflows. Have these funds' outflows crossed the line into the destructive kind? Read on.

Karen Dolan is director of fund analysis with Morningstar.

 Schwab YieldPlus 
This fund like has been knocked off kilter with outflows. We estimate that the fund has seen roughly $11 billion (about 81% of its asset base) walk out the door in the past year through the end of May. The heavy redemptions aren't surprising given the shocking losses investors have faced; the fund has lost 29.1% over the past year through June 26--that coming from a fund that was supposed to provide a risk/return profile slightly higher than cash but still relatively safe compared with other assets.

The fund ran into trouble because it held heftier stakes in hard-hit corporate and nonagency mortgage bonds than its typical peer, and management underestimated the potential volatility of those holdings. It didn't take more than a couple of percentage points of losses before many shareholders bolted. In order to meet those redemptions, the fund was forced to sell securities at steep losses, which makes the chances of a full recovery nonexistent and the argument for sticking with it null as well. We made the fund an Analyst Pan because it's clear that redemptions are making things worse as the fund has ticked down almost every day.

 Fidelity Low-Priced Stock 
Performance here has remained strong despite a meaningful pickup in selling by shareholders. This closed fund has seen roughly $6.6 billion leave in the past 12 months through the end of May, which represented about 16% of its gargantuan size a year earlier. Coming up with $6.6 billion in cash can be hard to do, especially in smaller companies, but the fund has kept more cash on the sidelines in recent years. Its cash stake at the end of January 2008 was 14% of assets--high, compared with the fund's 6% average cash stake over the past 10 years--which actually ended up helping performance as most stocks have moved south in 2008 and cash stayed still. At this point, flows don't appear to have hurt returns so we'd hold on given manager Joel Tillinghast's proven success investing in smaller companies. In addition, if flows do become a problem, Fidelity could reopen the fund to new investors and perhaps offset some of the fund's outflows with new cash into the offering.

 Fidelity Floating Rate High Income 
This fund has seen almost half of its asset base redeem in the past year, but investors leaving the fund now probably don't appreciate the fund's capabilities and potential. This has been one of our favorite funds in the bank-loan category since we first selected Analyst Picks for the group in 2004, and it has only proved its worth lately. Its approach has been just the ticket since the bank-loan market seized up in mid-2007. The entire loan market has struggled, but lower-quality, less-secure fare has done worse, so the fund's avoidance of such issues has helped. And, as the fund has been hit by redemptions--as have all bank-loan funds lately--the manager's emphasis on more-liquid loans has helped her to sell off positions piecemeal and maintain the portfolio's weightings in her favorite issuers and sectors. In all, the fund has struggled to stay in the green during the past 12 months, but its 0.55% gain puts it at the top of its category.

 Harbor Large Cap Value 
More than three fourths of this fund's assets have left in the past year. That may be partly in response to the June 2007 management change or the lackluster performance leading up to it. Those outflows are a lot for a new manager to have to swallow, but the fund travels in liquid large caps and the absolute amount of assets is still manageable. Outflows bear watching, but we're not too concerned at this point.

A version of this article appeared in the May issue ofMorningstar FundInvestor.

Securities mentioned in this article



Morningstar Rating Morningstar Analyst Report
With Morningstar Analyst reports you can get our expert Buy/Sell opinions on over 3,900 Stock and Funds
Karen Dolan, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
Sponsored Links
Sponsor Center
Content Partners