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Weak Market Drives Record Fund Mergers


At the start of 2002, fund families held off merging or liquidating their weaker funds for one quarter while awaiting a market rebound. When it didn't come, fund share class mergers and liquidations skyrocketed back up to their record levels of 2001.

Only 126 fund share classes were merged or liquidated in the first quarter of 2002, according to Thomson Financial's Wealth Management group in Rockville, Md., an affiliate of MFMN publisher Thomson Media. In the previous eight quarters, there were an average of 269 mergers and liquidations per quarter, leading to a record 991 of these transactions in 2000 and 1,005 in 2001, according to Thomson.

However, in the second quarter of 2002, there were 406 fund share class mergers and liquidations, the most in any one quarter, and they are now on pace to break last year's record high.

"At the end of last year [into] the first quarter of 2002, everyone was really hoping a market recovery would take place. Fund families were saying, Let's see how things pan out' before deciding to merge or liquidate their less successful offerings," said Ray Amani, director of content solutions at Thomson. "When the market didn't turn around, fund families went back to consolidating their offerings."

The down market has forced firms to consolidate their product lines, concurred Matt McGuinness, an analyst with Cerulli Associates of Boston. During the bull market of the late 1990s, there was rampant product expansion as firms tried to be all things to all people, McGuinness said. Firms known for their expertise in certain categories built products in other categories to try to capture a bigger piece of the pie, and financial intermediaries began to work with fewer complexes that offered more complete fund lineups.

However, beginning in 2000 when the market began to head south and asset levels dropped, firms could no longer support all of those products and were forced to merge or liquidate many of them. The record pace of consolidations this year is an indication that fund families are no longer optimistic about a market turnaround in the near future, McGuinness said.

"There was definitely an expectation that this year would bring a more favorable climate," McGuinness said. "When that didn't happen, firms went back to the strategy of rationalizing their product lines."

The types of funds that were liquidated in the second quarter were not surprising for the most part. Among the leading categories were growth and income, domestic growth, small-cap and specific sector funds, particularly telecommunication products, according to Thomson.

"The current market simply can't support those [niche products] now," Amani said.

One surprise is that many municipal bond funds were merged in the second quarter, according to Thomson. That is startling because fixed-income investments have not only performed very well of late, but have been popular within the investment community and have drawn in a substantial amount of assets, Amani said.

One reason for the high number of municipal bond fund mergers is that Wachovia Corp. of Charlotte, N.C., completed its product merger with Charlotte, N.C.-based First Union's Evergreen funds this past quarter, following the bank merger in 2001. There is little sense for one firm to maintain two similar funds, especially municipal bond funds, and so the new Wachovia conglomerate has done away with many duplicative offerings.

In 2000, investment management firm consolidation was one of the main drivers of fund mergers and liquidations, but that has subsided. The main reason for the increased numbers in 2001 and the second quarter of 2002 is poor performance and low asset levels. Fund families typically set $50 million to $100 million as the watermark level for profitability. Below that level, economies of scale are diminished.

It has taken until this year for many of these once high-flying funds to reach asset levels low enough that they no longer are profitable, according to Thomson.