Reopened Funds Could Be a Smart Buy

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Plenty of top choices are available to investors; many of the best selections focus on small stocks.

Investors have been dumping mutual funds at a record pace lately, withdrawing $195 billion in the last quarter of 2008, according to the Investment Company Institute, a mutual fund trade group.

While shareholders have been fleeing, fund companies have been holding their own race, rushing to reopen funds that were formerly closed to new investors. For the first 10 months of 2008, 67 funds reopened, double the figure for the year before, according to fund tracker Morningstar.

Top-ranked funds that recently reopened include Dodge & Cox Stock, Fidelity Contrafund, and Sequoia. Should you consider buying one of the recently reopened funds? Yes. In the past, funds have delivered strong results after reopenings. In fact, a flurry of fund openings often signaled that markets were poised to soar. To appreciate why openings could be an omen of better things, consider what causes funds to close in the first place.

Portfolio managers often bar the doors to new investors in the late stages of bull markets. At those times, funds may be flooded with new investors who seek to join the crowds chasing returns. 

As assets grow, the managers need to buy bigger blocks of stock in order to absorb all the cash. But large trades can be difficult and expensive to execute. So fund returns can sink as assets grow. To protect long-time shareholders, funds stop accepting new investors.

In times like the current bear market, many investors reverse course and withdraw from their funds. To raise cash for redemptions, funds may be forced to sell stocks. That can frustrate managers who are required to dump holdings at a time when shares trade for bargain prices. To obtain more cash during bleak times, managers of closed funds may reopen them to new investors.

Often the funds reopen at the blackest moments—just before rebounds begin. For example, T. Rowe Price New Horizons, a small-cap fund, reopened in 1974, a difficult year when small stocks lost 20%, according to Ibbotson Associates. Then in 1975, small stocks leaped 52.8% and began a nine-year rally.

After closing during the roaring bull market of the 1990s, New Horizons reopened in 2002, a year when the S&P 500 lost 22.2%. In 2003, New Horizons gained 49.3% and began a three-year streak of strong returns. The T. Rowe Price winning tendency is not confined to domestic funds. After recording three losing years, T. Rowe Price International Discovery—which holds overseas stocks—reopened in 2003 and began a five-year streak of healthy returns.

What has T. Rowe Price been doing lately? The company has reopened T. Rowe Price Small Value and T. Rowe Price High-Yield.
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