Your fund's merger could change nature of the investment

YOUR FUNDS

October 03, 2006|By CHARLES JAFFE

The mutual fund industry is buzzing with news that two of its bigger players - Putnam Investments and MFS Investment Management - are up for sale.

Both firms are old-line, big-name management companies that sell their wares through financial advisers. Both have suffered in recent years from a company-choking mix of mediocre-at-best performance and bad headlines, having been on the wrong side of the fund industry scandals of 2003.

Looking forward to when their respective parents find suitable deals, both companies can be an example for fund shareholders of how to react when your manager goes through a merger, whether it is the firm buying new assets or the one giving up the chase.

While casual observers tend to lump Putnam and MFS together as scandal-tainted load-fund firms, the truth is a bit different. If the two companies were cars, MFS would be the classic, being sold to the collector who wants to keep hard-to-find spare parts, while Putnam would be the junker, being sold to the scrap yard because most of its value is in the metal framework.

Neither picture is particularly complimentary, but in car parlance - no matter how ugly the exterior - both cars run well, with attractive profit margins and cash flows that a new owner can love. (The current owners love those characteristics, and while they have confirmed the up-for-sale rumors, it's clear the companies won't be sold cheap.)

In the case of Putnam, any potential buyer is paying for assets, not acumen. The firm has about $180 billion under management - down more than $105 billion since the summer of 2001, according to Financial Research Corp. - but no truly great funds. Of the 53 Putnam funds tracked by Morningstar - lumping all the share classes together - not a single one gets a rating of four or five stars.

Couple that mediocrity with the lingering black eye Putnam suffered in the scandals and it's clear that whoever buys Putnam will capitalize on the firm's distribution connections but will merge the funds out of existence.

MFS, by comparison, has several funds earning Morningstar's highest marks, most notably aggressive growth and international offerings. The firm, with $168 billion in assets under management, also has some quality bond offerings.

That combines to make MFS more attractive to a firm that doesn't just want to bring cash into the fold, but which wants to keep some of the talent running that money, too.

Ultimately, that combination of circumstances is why names like Franklin Resources, T. Rowe Price, Eaton Vance, and John Nuveen keep popping up in speculation by industry insiders.

Other bidders will emerge, but for investors in funds that ultimately make news, any transaction bears watching.

For the shareholders of Putnam and MFS funds, a merger most likely ends when their funds are folded into similar offerings run by the acquiring firm. (The top MFS fund managers likely will stay with their fund, swallowing weaker offerings from the new parent company.)

On the surface, this is a step up, but shareholders should make sure that the merger is a true blending of like strategies, rather than a marriage of convenience.

If you bought a small-cap value fund, for example, and it winds up merged into a small-cap blend fund, the change could create overlap with other holdings, or just not be in keeping with your personal management style.

For shareholders whose fund managers buy Putnam and MFS, the issue is mostly one of capacity, namely whether the company has the staff in place to run all of the new money, particularly if they don't bring the current managers into the fold.

Other concerns for shareholders from both sides are asset bloat - where a successful fund becomes enormous through merger, and management struggles to put all that money to work as well as it has in the past - and the investor's own ability to keep the faith under new management conditions.

Investors who look at the fund they have after a merger is complete and don't like the view most likely should make a change. Without the belief that the merged fund can meet appropriate expectations, any run of perceived poor performance will send shareholders to the exit at the worst of times.

There have been other recent high-profile manager combinations - Legg Mason with Citigroup and BlackRock into Merrill Lynch - and while shareholders generally have come out of those deals better off, some have come away frustrated, feeling that the end result has been watered down management and performance.

"Shareholders whose firms go through a merger - buying or selling - need to watch their funds closely for a while," says industry consultant Geoff Bobroff of East Greenwich, R.I. "Not every deal turns out perfectly for the fund shareholders, and you don't usually know for at least a year after a merger is complete."

jaffe@marketwatch.com

Charles Jaffe writes for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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