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Funds Keep Beating Market

Sat., Oct. 25, 1997

In the midst of one of the greatest financial feasts in history, many people have worried that mutual funds would choke on their own success.

The bigger the funds get, the skeptics reason, the harder it becomes for their managers to perform. At some point, they simply could find it impossible to get out of their own way.

For much longer than many people thought possible, the funds have managed to keep growing without facing such a day of reckoning. But the critics say success in postponing the problem by no means signifies that it has been averted.

“In the short space of two decades, mutual funds have gone from mom-and-pop cottage industry to financial behemoth,” John Bogle, chairman of the Vanguard Group, the nation’s second largest fund organization, said. “Even as we bask in the success of our past, we may be sowing the seeds of failure.”

Among the perils Bogle cites: Concentration of financial assets and market power in a single industry and growth of individual funds to such huge size that they strain against natural limits of the marketplace.

It was once thought that a stock fund was in danger of getting too big when it reached $1 billion, or $2 billion, or $5 billion in assets. Beyond that point, it couldn’t keep acquiring more shares of its managers’ favorite stocks without becoming a dominant owner of those companies. Yet the alternative, spreading out the portfolio to different stocks, was problematic as well. The fund would increasingly come to represent the market itself and the managers’ expertise would yield fewer benefits.

Well, at last count there were 10 stock or stock-and-bond funds with assets of more than $20 billion apiece, several of them still producing five-year returns that beat the market indexes.

Bogle asserts that the disadvantages of size still stand as major obstacles for any manager. Seen in this light, the constant introduction of new funds makes sense.

Managers at many funds say there is no need to worry that demand for stocks and other securities to invest in will ever overwhelm the supply of those securities. But the supply of good investments is constrained by the number of enterprises that can meet the needs of their customers, and the ability of those enterprises to grow.

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