“The top-performing growth fund since the end of 2019 is $7.6 billion Baron Partners (BPTRX). The fund gained 149% in 2020—just a hair behind ARK Innovation's 157%—and an additional 31% in 2021, while ARK lost 23%. This year, the Baron fund has also held up better than the ARK ETF, as growth stocks have tumbled. Investors should be cautious about the Baron fund, however: Most of its recent gains came from just one stock, Tesla (TSLA), which accounts for 50% of its portfolio. The fund bought Tesla shares between 2014 and 2016, and instead of selling to keep its weighting in check as the stock rose exponentially, the fund let it run.”
(I guess it depends on your definition of “fund”.)
Excerpted from Barron’s (print edition) February 14, 2022
Comments
We have been cutting back. I think APPL and AMZN are likely to be better long term investments than TSLA, but they are all overpriced. It hurts to have to pay taxes, even at her lower income, but it is better than a 50% loss.
However, I didn't realize that Tesla comprised 50% of a Baron fund.
Yikes, that's a bit too risky for me!
I am kinda surprised the SEC lets him get away with it in a fund under the 1940s law. I haven't read the law specifically but I thought it required "diversification"
That is the problem with rule-making. There are feeder funds that hold 100% in another fund; the new wrapper may just have different ER and/or eligibility. This is a common practice in 401k/403b. Although that is different from holding huge % in one stock, it is hard to legislate concentration. If the SEC wanted to change this, it could have done this when it found feeder funds that were feeding into Madoff's ponzi fund.
https://finance.yahoo.com/quote/BPTRX/profile?p=BPTRX
In the 1940 Act, Congress defined a nondiversified fund simply as one that didn't meet the requirements to be called diversified. Just a basic partitioning of the fund universe into two parts.
https://www.law.cornell.edu/uscode/text/15/80a-5
What @sma3 might be thinking of is not a section of the 1940 Act (under which investment companies are registered), but rather 26 U.S. Code § 851 that defines regulated investment companies. That's a more expansive category that includes 1940 Act registered investment companies and also some common trusts that do not fit the definition of an investment company.
In any case, this statute requires that with respect to half (50%) of the fund's assets, the fund cannot invest more than 5% in a single security (other than government bonds). That leaves the other 50% to play with.
However, a second part of the statute prohibits the fund from investing more than 25% of its assets in a single company. That is the part that I've wondered about with funds like FAIRX. There is an exception if the increased percentage is due to market fluctuations. See Example 6 in the examples below.
Here are some examples of how this statute plays out.
https://www.law.cornell.edu/cfr/text/26/1.851-5
>> prohibits the fund from investing more than 25% of its assets in a single company.
Assuming investing also entails having, I guess the answer is managers are supposed to (quickly? is there a time schedule?) whittle down, or whatever the phrase is. Unless I am missing something.
the OP quoted from Barron's
Most of its recent gains came from just one stock, Tesla (TSLA), which accounts for 50% of its portfolio.
so I was not seeing the problem, not seeing any problem. Then you posted
It's hard to think of this as a mutual fund when 50% is in one stock.
(and the answer to your question 'Why not just buy that stock?' is that you still want active management, presumably.)
A colleague who writes European prospectuses ventured:
... if an investment policy violation occurs (over a maximum, under a minimum, bond downrated to below credit threshold, etc.), the manager must make it a priority to resolve the problem as soon as possible within the normal course of business. So you don't have to suddenly dump so many now-junk bonds on the market that you push down the price you get for them, because that is not in the shareholders' best interest --- which is the paramount test for anything a fund does or doesn't do, though somehow they've managed ways to persuade regulators that giant fees are in the shareholders' best interest.
But yes, you gotta ditch the stuff or, as likely, offset some of the exposure through short sales or derivatives or whatever. This is an actual reg, not just a policy, and is about diversification and smoothing out volatility, and it is so heart-and-soul a mutual fund feature that you gotta follow it, eventually.
To see how this could happen, suppose the fund bought TSLA at $0 (or for a penny if it makes people more comfortable). Assume that the fund's holding in the company is now worth $5.6B; the other $1.3B are in assets that have not appreciated.
Fund shareholders redeem $5.6B worth of shares. The fund, perhaps foolishly, decides to satisfy the redemptions by selling all its TSLA stock. The fund is left with $1.3B in assets and a gain of $5.6B. When December rolls around, what does the fund distribute in the way of cap gains dividends?
One possibility is for the fund to distribute $1.3B in divs, and carry forward the remaining gains. The pragmatic problem with that solution is that no one would buy shares of a fund that would immediately distribute 100% of the investment back as a cap gain. Talk about buying a dividend! I don't know the real answer to what the rule is.
That said, I really like the idea of redemption in kind. Normally that's a pain for the retail investor, but here, where there's a single stock (or two) distributed, it's a very good thought. Even better (for the investors) because redemptions in kind make cap gains go poof. That's the loophole that ETFs use, and it's a generic loophole for all types of funds.
26 U.S. Code § 852(b)(6):