Funds are often subject to capacity constraints, meaning investors can sometimes be deterred or blocked from investing any more money once the funds have amassed a certain amount of assets.

While it may appear odd to close a fund that is successfully attracting investment, there are very good reasons to do so.

Unit trusts and Oeics are two types of open-ended funds. The fund manager has to find suitable investments each time someone puts money into these types of funds.

Some fund managers have a short list of companies or other assets that they’d be prepared to back. A stream of new money into their fund raises the risk that they keep buying the same things and paying a higher price each time they invest. Overpaying for assets can dampen future returns.

One alternative is to expand the search criteria and invest in companies or assets which weren’t originally targeted by the fund managers. That raises the risk that the fund doesn’t perform as expected.

How big is too big?

There isn’t a specific figure which dictates when a fund is
too big. Instead, it depends on the type of assets being targeted by the fund.

For example, there are numerous funds with more than £5bn of assets such as M&G Optimal Income (GB00B1H05601) at £17.17bn; and Fundsmith Equity (GB00B41YBW71) at £11.89bn, according to data from Morningstar. The former fund has regularly come under criticism for being too big yet still attracts more money.

In contrast, Downing UK Micro-Cap Growth Fund (GB00B2403R79) was soft closed earlier this year after reaching £30m in assets. You might think that’s far too small to think about blocking new money, yet it only every wanted to own 25 to 30 holdings in companies typically worth less than £150m.

Having endless amount of cash risked investing in too many stocks or owning too much of an individual company which risks having to make a full takeover offer under listing rules.

In the exchange-traded fund space, VanEck Vectors Junior Gold Miners ETF (GDXJ) was recently forced to invest in much larger companies than its original plan after becoming too popular. It ended up having significant-sized positions in underlying holdings, putting it at risk of violating certain Canadian and US regulatory thresholds.

How does a fund discourage investors?

The popular route is to ‘soft close’ a fund. That tends to involve imposing a high initial charge to dissuade investors from investing more cash into the fund. The exception is usually monthly savings schemes which are generally allowed to continue without the new charge, if they’ve already been set up prior to the soft closure.

For example, First State Global Emerging Markets Focus Fund (GB00BZCCYH32) was recently soft closed by applying a 4% initial charge to new subscriptions from 28 September.

Another route is to ask investment platforms to
stop featuring a fund in their selection tables.

Sometimes a fund is ‘hard closed’ which means removing the product from fund platforms altogether for new investments.

Can funds reopen for new business?

Closed funds can be reopened for various reasons, such as a change in valuations for a target market.

For instance, Henderson UK Absolute Return Fund (GB00B5KKCX12) has been reopened twice. According to Ryan Hughes, head of fund selection at AJ Bell, this was due to the fund’s investible universe getting bigger and redemptions improving liquidity.

A fund investing in niche areas such as a specific emerging market may reopen if the target country’s stock exchange has grown in size and stature.

What happens if a fund is deemed to be too small?

Detlef Glow, head of Europe, Middle East and Africa research at Thomson Reuters’ fund information provider Lipper, says small funds can be more expensive to run and may be closed if they don’t attract enough money.

If a fund only has a few million pounds or dollars in assets then the costs of compliance and paying an accountant can make its total expense ratio much higher than a fund with a greater amount of assets.

For example, Henderson HF World Select’s assets were liquidated earlier this year after the directors concluded the $4.1m fund was unlikely to grow further. It was deemed too small to manage in a cost effective way.

A fund that remains small in terms of assets may be down to a lack of popularity. That could again lead to the fund being closed early. The alternative is to merge the product with another fund to gain scale. (DS)

Disclosure: Editor Daniel Coatsworth has a personal investment in Fundsmith Equity mentioned in this article

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