The weaker funds are getting eaten in record numbers this year

Your Funds

Dollars & Sense

April 29, 2001|By CHUCK JAFFE

FUND companies are closing and merging funds at an unprecedented pace this year.

The trend is a combination of several factors, including stock market declines, fund economics and marketing realities. If the trend continues and increases, it could impact the thinking of investors considering small mutual funds.

According to Wiesenberger Thomson Financial, a Maryland-based tracker of fund data, there were 188 mutual fund mergers during the first quarter of 2001, up 55 from the first quarter a year ago. In addition, 40 more funds were liquidated during the first three months of the year, a record pace for shutdowns.

Those numbers represent an annual pace in which roughly 8 percent of all funds that started the year could be gone by the time we reach 2002.

While some big, brand-name funds are being put down (Strong Funds, for example, recently announced plans to merge its Discovery fund out of existence), most of the mergers and closures involve small funds. The stock market climate slowed the pace of merger activity between fund parent companies, so that most closings and combinations taking place are not the traditional merged-firm-combines-similar-funds deals but the parent-stops-feeding-the-runt-of-its-litter variety.

A small fund group may be able to turn a profit on a tiny fund, but it usually takes $25 million to $50 million to be profitable, and it may require that management charge a high expense ratio to make the profits worth the exercise. But funds that small may have signed guarantees with transfer agents requiring certain minimum account sizes or total assets; falling short of those minimums (and the current market downturn pushed many small funds beneath those levels) can force the management firm to pay up to make the guarantee.

Transfer agents will let a small fund slide, for a while. Now that the market downturn has lasted more than a year, the grace period appears to be over. Faced with higher costs to run the funds and lower profits from managing the money, many small firms are looking at liquidation as an alternative. That means the current size to ensure that a stock fund from a small firm can remain viable is in the range of $50 million to $100 million.

At a large firm, the threshold is likely to top $100 million and maybe pass $500 million. No firm with $25 billion in assets under management wants to devote too much time, energy and talent to a $25 million fund with limited prospects.

Even if management believes that a fund can rebound in the market, it may kill a fund for loss of potential in marketing.

"Many start-ups don't have the resources or the record to weather the storm," says Geoff Bobroff, a fund consultant based in East Greenwich, R.I. "They were created as an outgrowth of the technology bubble and many are down significant percentages from where they came to the market or from their high.

"It is extremely difficult to repair a damaged track record, because it takes either a big rebound or a long time with steady gains. Most fund companies aren't going to wait. They'd rather kill off the current track record and start fresh when the timing is better."

The timing issue for investors involves whether to buy a small fund with a rocky recent history. Many investment experts believe that the market downturn has made certain sectors - most notably technology - something of a bargain at current prices. But while pursuing out-of-favor sectors might be a good investment strategy, buying a fund that is out-of-favor with its management company is just asking for a headache.

Most mergers are not taxable events; liquidations, however, force a "sale" from a tax viewpoint. The "good news" is that most investors in the downtrodden funds being shuttered don't have much in the way of capital gains to worry about. The bad news is that finding another fund and moving your money around is still a hassle.

Experts agree that's no reason to alter your bargain-hunting strategy; it's just a reminder that only the strongest funds can be counted on to survive.

"If I want to play some money for a rebound, it's not going to be in some $10 million fund that is young and has more potential than track record," says Russell Kinnell, director of fund analysis at Morningstar Inc. "Even some of the more established firms may kill off track records, so you could end up merged into some fund that wasn't quite what you wanted."

Chuck 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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