Mercy killing can be the answer for a sick fund

Your Funds

Dollars & Sense

April 09, 2000|By Charles Jaffe

It's not often that a fund company gives your money back and says it doesn't want it anymore.

Yet a small-but-growing number of fund firms are doing just that by killing off unpopular and mostly unloved issues.

Munder Value, N/I Numeric Larger Cap Value, and three Van Kampen funds announced liquidation plans in March. Skyline merged two small-cap funds into its flagship Special Equities fund, and AIM announced that it will fold the remaining funds it bought from GT Global into existing AIM issues.

With thousands of undistinguished funds languishing in mediocrity, it's a trend that is likely to escalate.

"If you have a small fund without a lot of assets, you have nothing to lose by closing it and a lot to lose by keeping it open and having a bad track record out there," says Don Phillips, president of Morningstar Inc. "A lot more funds deserve to be closed, but most fund families have kept hanging on. -- That could be changing."

Fund companies support ailing funds because: 1) They don't want to lose the fees they get for managing the assets and 2) Many data firms demand a longer track record before rating a fund, meaning that management is more likely to hold out for a rebound than to commit a mercy killing.

Funds that are liquidated tend to be small offerings in which shareholders have held on through a protracted period of undistinguished performance. Munder Value, for example, is up an average 12 percent per year since its 1995 inception, but has been a laggard the past three years. N/I Larger Cap had $15 million in assets a year ago, but a 10 percent-plus loss in 1999, and subsequent redemptions had driven the fund down to less than $3 million when it announced its intentions.

Big fund firms tend to operate in a survival-of-the-fittest mode, killing off weak offspring. They may even close a fund in an out-of-favor sector today, but open a new one -- unencumbered by a poor record -- when the asset class heats up in the future.

Small "boutique" firms, meanwhile, generally can't find a buyer for any fund with less than $50 million in assets.

What's more, management in these tiny funds isn't making so much money that it's worth staying open indefinitely: A mutual fund with $2 million to manage and an expense ratio of 3 percent (about double the norm for a stock fund) generates a total of $60,000 a year to the management company, hardly enough to pay the salary of the manager and staff and other costs.

That's not what the managers envisioned when they opened the fund.

(According to Lipper Inc., roughly one stock fund in five has total assets of $4 million or less.)

When a fund liquidates and sends money back to shareholders, investors who do not hold the fund in tax-advantaged accounts must pay taxes on any gains. By comparison, a merger triggers no tax bill, but can mess up an investor's asset allocation.

Numeric Investors chose liquidation because Larger Cap Value's closest siblings were mid- and small-cap funds.

"People bought the fund for a purpose, and the other funds don't serve that purpose, so the right thing was to close the fund rather than merge it," says company spokesman Lynn Wickwire.

Not all fund firms are so magnanimous with shareholder money; in 1998, for example, the Rightime government bond fund was merged into Rightime Blue-Chip Stock, a move that clearly did not have shareholder asset allocation in mind.

To avoid having their investment strategy messed up by a merger, shareholders can sell -- which triggers the same tax event as a straight-out liquidation. (If they have losses in the fund, investors can at least get some tax benefit to the liquidation by using the shortfalls to offset their gains in other funds.)

Investors can vote against a liquidation or merger in a proxy, but the plain truth is that such a vote is not going to change the outcome.

Besides, why stick around in a fund when management has said it doesn't want to run the money anymore?

That said, investors can sell (or transfer to another fund in the family) when the liquidation notice arrives or ride it out to the bitter end.

"There are a lot of funds out there that deserve liquidation because they really aren't doing a great job serving investors," says Phillips. "That said, if your fund is the one being liquidated, it's not really good news because it says that you probably have been holding a lousy fund for a long time."

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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