A mutual fund started by another mutual fund as a result of the parent fund's large growth and management's assessment that the parent is limited as to the investments it can make. For example, a very large fund would generally be unable to establish investment positions in small or new corporations. Thus, a new, smaller fund with the same goals as the older, bigger fund is started. Although the parent fund and clone fund have the same investment objectives, they purchase different securities and generally operate under different managements.
Case Study Many finance professionals believe that mutual funds can become so large that investment performance is hindered. Managers of mutual funds that have a huge amount of assets are restricted in the securities that can be added to their portfolios because of the large size of transactions these funds typically undertake. For example, a large fund generally cannot establish a position in the stock of a relatively small firm simply because of the limited number of shares that trade. Even if the fund could acquire a stake in the firm, the amount invested would represent such a tiny proportion of the fund's assets that the fund's investment performance would be little affected. Similarly, a big fund may have difficulty unwinding a large position in a security with limited trading volume. In 1995, the manager of Fidelity's Magellan fund, America's largest equity fund, took at least two months to sell the fund's 11.8-million-share stake in Micron Technology. The manager of a relatively small fund can take investment positions in the stocks of both small and large firms without worry that the fund's transactions will have an effect on the prices of the securities. Mutual funds may also become more difficult to manage as they grow in size. More assets mean bigger trades and a larger number of securities to track. Some fund sponsors stabilize the size of a rapidly growing fund by closing the fund, thus halting the sale of shares to new investors. Closing a fund is sometimes followed by the introduction of a new clone fund that has an investment philosophy virtually identical to the closed fund. Vanguard closed its Windsor fund to new investors in 1985 and at the same time started successor Windsor II, a clone of the closed fund. Likewise, the Putnam Fund for Growth & Income was closed in 1994 when the firm launched the clone Putnam Fund for Growth & Income II.What are clone funds, and are they as good as the real thing?
Rocky versus Rocky II. Clone mutual funds are replicas of existing funds. They are set up for several reasons. The managers of a fund may conclude that if it becomes any bigger it will be too unwieldy (this was true of the Windsor Fund). Or the group may want to introduce a new pricing structure. (Most Massachusetts Financial Services funds now have A, B, and C shares: the first with a front-end charge, the second and third with redemption charges, depending on when they are sold, and higher annual fees but no up-front charge.) Or a new fund may have similar but slightly different objectives. Finally, when a group successfully pioneers a new type of fund, imitators inevitably follow. (Benham Target Maturities broke new ground for investors planning for retirement with a series of zero-coupon bond funds; the following year the Scudder group followed suit.) There is no reason in principle why the clone should perform worse or better than the original. Throughout the years, the Pioneer Fund often beat Pioneer II (renamed Pioneer Value Fund in 2001), but then Pioneer II often beat the Pioneer Fund! The investor should keep in mind, however, that the two funds are different. They may have different portfolio managers, perhaps some difference in investment outlook, and perhaps different fees. The simple rules then, when looking at a new clone fund, are first, take into account what the original has done—clearly that is a crucial piece of evidence. And second, research the differences.Reg Green, Editor, Mutual Fund News Service, Bodega Bay, CA
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.