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When funds merge, it's decision time for investors
Even if mutual fund investors want to follow a buy-and-hold strategy, sometimes their hands are forced.
A fund they hold is suddenly being liquidated or merged into another. Investors must find another place to put their money or, in the case of a merger, decide whether to stick it out with the new fund.
Last year 357 funds disappeared through mergers and liquidations, the largest number since 2001 when many companies killed off funds created in the 1990s bull market, according to research firm Morningstar Inc. This year 117 funds have been eliminated.
The increase in merged and liquidated funds last year is largely owing to consolidations among investment companies, said Jeff Tjornehoj, a senior research analyst with fund tracker Lipper Inc. Once the dust settles on an acquisition, a company will jettison duplicate or lackluster funds acquired in a deal.
That's the case with Baltimore's Legg Mason Inc., which recently announced it was cutting nearly one-third of its funds. Most of those being eliminated are part of an asset-swap deal with Citigroup Inc. last year.
But consolidations are not the only reason companies prune their fund tree. Companies sometimes merge a weak fund into a strong one to purge the underperformer's record, experts say. "You want to put your best foot forward when touting your line to the public," Tjornehoj said.
Many companies also launch funds to tap into the latest trend and eliminate them once they fall out of fashion.
"It's like all those powder-blue tuxes," said Conrad Ciccotello, a finance professor at Georgia State University. "You start looking at the photo album of the 1970s and say, `What were we all thinking?'"
Whether your fund is being merged or liquidated, it's time to take control. Look at your options and see where your money would be put to best use.
Liquidations are less common than mergers. Basically, with a liquidation, the fund's securities are sold and investors get money back. Fund companies prefer merging funds to keep the assets.
"Liquidations are the last resort," Tjornehoj said. "It's the fund company saying, `We ... couldn't make this work.'"
If your fund is being liquidated, sell it as soon as you line up an alternative, said Russel Kinnel, director of fund research at Morningstar.
"Clearly it's not a great fund," Kinnel said. And liquidation is expensive, as securities are sold and temporarily parked in Treasury bills, he said. In its dying days, the fund is essentially a high-cost money market fund.
"Why wait?" Kinnel said. "If you got something lined up, pull the trigger."
If your fund is being merged into another, other considerations should be weighed.
Investors in the fund being acquired need to approve a merger with another fund. Often a merger is a good deal for these investors because the new fund tends to be larger with lower fees and better performance, experts said.
It might be a little less advantageous for investors in the fund doing the acquiring. Edward Nelling, an associate finance professor at Drexel University, studied hundreds of fund mergers from the 1990s. He said the acquiring fund's performance declined slightly in the year after the mergers, but not enough for investors to be alarmed. One explanation is that fund managers became distracted trying to decide what to do with the securities from the defunct fund, Nelling said.
Investors in the acquired fund should look at who will manage their new fund. If you invested in a fund for its manager, does a change at the helm matter to you? Look up the new manager's track record.
Similarly, check out the new fund's performance history against its peers. Review the new fund's investment strategy.
Usually, merged funds have a similar style, but they might not be a close fit. A Pacific fund, for instance, might be combined with an international fund that also invests in other regions.
How would a shift in the fund's objective fit with your portfolio? If your large-cap growth fund is merged with one that's large-cap growth and value, then "half of your reason for investing is gone," Tjornehoj said.
Check out the new fund's fees. Often costs are lower. Funds being eliminated tend to be small and cannot benefit from economies of scale. Also, if the acquiring fund gains enough assets through the merger, it should be able to further reduce fees, Kinnel said. But lower fees aren't guaranteed. Investors should make sure they are not being merged into a fund with high fees that erode returns.
What's too high? As a guideline, Kinnel said, annual expense ratios for actively managed funds should not exceed 1.25 percent for stock funds and 1 percent for bond funds.
If you're still unsure whether to remain with the new fund, ask: Would you invest in it if not for the merger?
"If the answer is yes, by all means ride it out," Tjornehoj said. "If you don't feel comfortable with the fund and it doesn't satisfy your objective or is riskier than you want, then there are thousands of choices out there."
Eileen Ambrose is a columnist for The Baltimore Sun, a Tribune Co. newspaper.