Fidelity has just announced that their flagship Magellan fund, which has $45 billion of assets, will reopen to new investors. The fund, which once reached over $100 billion of assets, had been closed to new monies since 1997.
A cynic could ask why the fund is being reopened now. Fidelity state that inflows are needed to balance redemptions thus giving the manager the best opportunity to deliver good investment returns. But redemptions are not a recent phenomenon – poor investment performance cannot account for a 55% fall in assets.
Is it a coincidence that the fund is reopening after a period of excellent performance? The current manager outperformed the S & P 500 index, a broad measure of the US stockmarket, by over 13% in 2007, the best performance the fund has seen for many years.
I’m sure Fidelity will not have any problems enticing new investors into the Magellan Fund. Investors persistently select investments that have performed well recently, as they believe that this good performance will continue in the future. The same ‘logic’ drives investors to cash out after a period of poor performance and seek out another successful manager. I described this self-defeating phenomena in my article ‘The Human Brain – are we programmed for investment success?’
History and logical reasoning show that large fund inflows make a manager’s task exceptionally difficult, if not almost impossible.
When Peter Lynch took over the Fidelity Magellan fund in 1977 it had assets of $22 million. When he retired in 1990 the fund stood at $14 billion. This huge increase in assets occurred after 1983, when he became publicly known following his exceptional performance. Lynch became one of the first modern money managers to achieve ‘cult’ status.
However, with his new found fame and fund assets Lynch realised he could not follow his previous investment strategy. Initially he could buy small unknown companies that other managers and analysts had overlooked. As the fund grew he simply could not find enough of these stocks to buy, or he could not deal in the quantities he needed to. He was forced to invest in larger more liquid companies. Unfortunately this area of the market attracts considerably more coverage by analysts and managers and thus provides less chance to uncover ‘undervalued’ stocks. This competition from managers drives out the easy excess returns that can be available in more esoteric market segments. Peter Lynch’s overall record was outstanding over his 13 year tenure, but investors who bought in after 1983 did little better than the overall market. His incredible stockpicking ability had become overpowered by the shear weight of assets he was forced to invest. Peter Lynch retired as a fund manager in 1990, aged 46.
The Peter Lynch and Magellan fund story highlight a number of cold hard truths in the modern investment management world.
- Managers can be more nimble and can take advantage of potentially lucrative opportunities, without impacting upon a share price, when they manage small amounts of money.
- The combination of good recent performance and seductive marketing by fund management companies attracts massive cash inflows into successful funds, as investors chase good past performers.
- Large cash inflows and large funds make a manager’s job increasingly problematic, as he struggles to make investments of enough size and scope for good returns. The larger a fund becomes the more it tends to replicate the overall market as a manager has to spread his investments, further diluting his previous successful style.
It will be interesting to review the Magellan fund performance over the coming years, but I can’t say that the signs are good.
Email Christian Ward 
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