The Dark Side Of the Urge to
By Ali Jaffery
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mutual fund world seems poised to shrink, but that might be a more
pleasant and profitable experience for fund companies than for the fund
Investors' low morale and with the S&P 500 underwater over the past three
years, it is a recipe for a continuing wave of mergers within fund
families and among asset managers.
Fund mergers are often presented as a win-win proposition. For fund
managers they erase poor performers without diminishing a manager’s assets
or sapping its fee income. And for shareholders of small, battered funds
they land them in supposedly better options.
But holders of large funds have reason to be wary if their funds' become a
graveyard for small stragglers. These acquiring funds often see returns
buckle under the weight of the inherited stocks and shareholders.
When two funds merge, the target or vanishing fund's holdings are added to
the acquiring fund's portfolio. Shareholders of the vanishing fund end up
with an equal investment in the acquiring fund.
On balance, the marriages are positive for shareholders of target funds
who usually see their returns rise and their expenses drop. But
shareholders of the acquiring fund -- often a larger group -- don't do so
The vanishing funds' shareholders see better post-merger returns because
they're invested in a portfolio that has performed better and also has
lower expenses. Since the acquiring fund is usually larger, it's fees tend
to be lower, taking less of a bite out of returns.
While mergers can give a fund company a relatively painless way to sweep
sagging funds under the carpet, they can make it tough for fund investors
to measure a firm or fund's quality. In the somewhat rare instances where
a larger, mediocre fund merges into a smaller fund with a better record,
you're left with a large fund whose record was built with a much smaller
The merger trend should continue as fund companies look to rationalize the
glut of stock funds rolled out in the 1990s. Ten years ago there were
about 880 US stock funds and since then their ranks have nearly
quadrupled. Industry vets say most stock funds need between $50 million
and $80 million to cover their costs. Today more than 1,000 US stock funds
have less than $50 million in their coffers and stocks' anemic returns
leave many of these minnows with little hope of gathering assets any time
soon. The bleak situation could also trigger more mergers among asset
The bottom line is that fund mergers can pretty up a manager’s lineup but
for the investor they should raise a red flag.
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