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50% of this fund is invested in 1 stock.

edited February 13 in Fund Discussions
“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

  • I have a chunk of my daughter's account in BPTRX since 2003. Needless to say she thinks I am a genius, although her suggestions to buy APPL and AMZN in 2012 and 2014 have actually done better.

    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.
  • I knew that Ron Baron was really fond of Tesla.
    However, I didn't realize that Tesla comprised 50% of a Baron fund.
    Yikes, that's a bit too risky for me!
  • Baron has in general run very good funds and has been able to attract and keep good employees

    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"

  • edited February 15
    The SEC has rules for diversified vs nondiversified funds. BPTRX is nondiversified.

    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
  • msf
    edited February 15
    The SEC has rules for diversified vs nondiversified funds. BPTRX is nondiversified.

    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
  • It's hard to think of this as a mutual fund when 50% is in one stock. The other issue I could image is the potential tax liability if the fund starts experiencing redemptions and the manager has to sell appreciated stock. Given that, if one is a Tesla fan, why not just buy Tesla directly? According to the fund's June 30, 2021 semiannual report--https://sec.gov/Archives/edgar/data/1217673/000119312521257076/d171358dncsrs.htm#cov171358_33--the fund had $5.6 billion of unrealized capital gains in its $6.9 billion portfolio. One could easily imagine the fund distributing some hefty taxable distributions if some of those unrealized gains have to be realized because of shareholders selling the fund.
  • Thanks for all the information. As I said, we have been whittling down the position
  • edited February 16
    Dumb question, must be missing something --- how does it (is it supposed to) work when one of the holdings increases just stupendously and thus goes far above some percentage threshold ? Are managers somehow obligated or mandated to sell to get the percentage of the total back down?

    >> 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.
  • My impression is that as long as the purchases of the stock did not exceed 25% of the fund's assets, the manager can have as much of the stock as a percentage of the portfolio as they want if the stock has appreciated beyond that 25% threshold. I don't think they're required to sell the position down, but they wouldn't be able to add to it.
  • yeah

    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.
  • msf
    edited February 16

    It's hard to think of this as a mutual fund when 50% is in one stock. The other issue I could image is the potential tax liability if the fund starts experiencing redemptions and the manager has to sell appreciated stock. Given that, if one is a Tesla fan, why not just buy Tesla directly? According to the fund's June 30, 2021 semiannual report--https://sec.gov/Archives/edgar/data/1217673/000119312521257076/d171358dncsrs.htm#cov171358_33--the fund had $5.6 billion of unrealized capital gains in its $6.9 billion portfolio. One could easily imagine the fund distributing some hefty taxable distributions if some of those unrealized gains have to be realized because of shareholders selling the fund.

    This situation suggests an interesting problem which I've never researched. What happens if the realized gains in a fund exceed the assets in the fund?

    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.
  • In this extreme hypothetical example, each $1 redemption in TSLA would create $1 in realized CG distribution liability, and the point when the fund would be broke is when it still has $5.6B + $1.3B - $6.9B/2 = $3.45B in nominal assets, but $0 in unencumbered assets. Probably, the SEC or a fund acquirer would step in well before that point.
  • edited February 16
    I would suspect in such a circumstance the fund wouldn't wait until December to make a distribution, but to pay special distributions earlier, closer to the time of the redemptions. It is also possible for a fund to pay in-kind redemptions in securities within the portfolio. That would be one way I imagine to get the gains out of the portfolio, just give redeeming shareholders shares of Tesla, and they would have to liquidate it and pay the gains on it themselves if they chose. The other reason this scenario is so unlikely is that shareholders don't make those kinds of redemptions unless the fund is doing poorly. A more probable scenario is the fund goes down say 20% first and shareholders sell a lot but there are still significant gains embedded in the portfolio the fund must distribute. So shareholders who stick around have a loss for the year in the fund plus a hefty gain distributed to them to pay taxes on.
  • While I agree that the scenario is unlikely, it's still a valid hypothetical question and I don't know the rule that handles this.

    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):
    Section 311(b) [saying that funds recognize gains when they sell holdings] shall not apply to any distribution by a regulated investment company to which this part applies, if such distribution is in redemption of its stock [fund shares] upon the demand of the shareholder.
  • edited February 16
    In practice, though, in-kind redemptions are relatively impractical except for large institutional shareholders, but could be useful when funds are facing dangerous redemptions from such institutional players. A lot of investors who sell might never come back to a fund company that hands them stocks to unload instead of cash when they sell. The record-keeping and calculations for fund companies and brokers making such in-kind redemptions especially for retail shareholders could be tricky and cumbersome--the cost basis of distributed shares, the fractional shares for retail investors, the anonymous omnibus accounts at brokers. The other alternative not discussed is funds can in emergencies use a line of credit to handle redemptions.
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