By Ben Baden

When a fund swells in size, experts sometimes worry about "asset bloat"

For years, the world's largest bond fund, PIMCO Total Return, has consistently delivered returns that rank near the top of its category. Since the fund's 1987 inception, it has gained an annualized 8 percent, outpacing the average fund in Lipper's intermediate investment-grade debt category by almost 2 percentage points. With manager Bill Gross at the helm, the fund (symbol PTTAX) has outrun 93 percent of its peers over the past decade, according to Morningstar. But now that the fund's assets have reached almost $250 billion, experts are wondering if Gross can continue to blow past the competition.

When a fund swells in size, "asset bloat" becomes a concern. When a fund has a giant asset base, its manager may have trouble maneuvering in and out of positions and investing in certain securities. But the degree to which asset size affects a manager's ability to do his or her job depends on the type of fund and strategy its manager employs.

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"Typically, there is not much of a concern for bond fund managers," says Senior Lipper Analyst Jeff Tjornehoj. Many bond-fund managers like Gross make large bets on highly liquid areas of the bond market, such as investment-grade corporate bonds or U.S. treasuries instead of bonds issued by individual companies. Since Gross isn't focused on individual bonds, the size of the fund isn't as much of a concern, Tjornehoj says. Gross also invests extensively in derivatives, such as futures contracts, which gives him even more flexibility. "At this point, [asset bloat] doesn't seem to be an issue," Tjornehoj says.

The effects of asset bloat can be more problematic for stock fund managers, however. For example, large-cap growth fund Fidelity Magellan (FMAGX) has struggled to compete with its peers for years, partly because of its unwieldy asset base. "Fidelity Magellan is one of the classic cases of why fund size can be a real problem," says Russel Kinnel, director of mutual fund research for Morningstar. In late 2000, the fund's assets peaked around $110 billion, and it wasn't long before its returns began to lag its peers. Over the past 15 years, Magellan has finished in the bottom half of its category, and over the past decade it ranks near the bottom quartile of its peers, according to Morningstar. "Magellan has steadily been in redemptions because performance has been so poor," Kinnel says.

Today, Magellan's asset base is relatively smaller -- $20 billion -- under manager Harry Lange, who took Magellan's reins in 2005. Lange takes a company-specific approach, in which he analyzes valuations and a company's potential to grow. That investing style requires a more nimble asset base.

Some stock funds have strategies which allow them to remain successful even with a large asset base. With about $170 billion in assets, American Funds Growth Fund of America (AGTHX) is currently the largest actively-managed stock fund. Kinnel says the American Funds can generally handle large sums of money because each fund is managed by a team, the members of which are each assigned to oversee an individual slice of the fund's portfolio. Kinnel says the fund has become somewhat "index-like" because of its ballooning size, but he adds, "it's not going to result in terrible returns."

Investors should be most concerned about asset size in more niche corners of the market, such as small-cap stock funds. "If a small-cap manager has $10 billion to invest, there aren't that many stocks he can buy without moving the market and showing everyone that he's buying this small, but worthwhile, company," Tjornehoj says. "The risk there is that managers become inefficient when they're handling large sums of money and directing it to very small stocks." Generally, managers aren't allowed to own more than 5 percent of a single company, Tjornehoj says. That's why small-cap funds close to new investors more frequently than large-cap funds.


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