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Small Funds Tough Out New Regulations


Dire prognostications that the slew of new strict and costly regulatory requirements will drive small-fund managers to bail out from the mutual fund business in droves, have not materialized. At least not yet. But new rules have caused advisors to take a fresh look at their fund business.

While several small-fund managers have filed notices with the SEC in recent weeks acknowledging that they will close up and liquidate their funds, the exodus is not as severe as fund industry pundits had predicted.

"We are not seeing the rapid fund closings that were predicted," noted Joe Neuberger, SVP of U.S. Bancorp Fund Services in Milwaukee. "We could see an increase in advisors deciding to get out of the business if there is a continued layering of regulatory mandates, or a downward spiral in the market," he suggested. But for now, it is business as usual at many small-fund shops, he said.

U.S. Bancorp provides back-office operational services to mutual funds. But it also offers a more cost-effective "series trust" turnkey structure for new, niche or small funds looking for a chosen administrator to handle all of the non-investment functions including assembling a prefabricated board of directors for the fund. U.S. Bancorp has two series trusts that are identical in structure: the Advisors Series Trust and Professionally Managed Portfolios. Each serves as the umbrella for several independent mutual funds.

Several fund administrators offer similar trust structures under which unrelated mutual funds operate. Series trusts were originally designed to be the incubators for small funds that would eventually grow to and become standalone fund groups. But in recent years, there's been a reluctance among these fledgling funds to ever leave that nest. These are the people closest to many of the tiniest funds and the most tapped into their collective worries.

Series trust administrators include Federated Investors of Pittsburgh, SEI Corp. of Oaks, Pa., which offers its Advisors' Inner Circle series trust, Unified Fund Services of Indianapolis, which sponsors the Ameriprime Funds series, and First Dominion Capital of Richmond, Va., which is the provider of the World Funds series trust.

Although there hasn't been a mass exodus of managers, the new regulatory operating environment has prompted many to consider alternatives, said industry executives. "People have gone through the discussions, and some have decided it's time to close their doors," Neuberger said. But others are asking if they have already weathered the worst of the storm, he added. The good news is that as fund managers get closer to this week's Oct. 5 deadline for securing a fund's chief compliance officer and having muddled through the first of related reporting requirements, fund companies are realizing that the cost is not as high as was anticipated, Neuberger added.

Among the smaller funds deciding to throw in the towel is the Columbia Partners Equity Fund. In July, it gave notice that it would close at the end of August. The Sirach Bond Portfolio, one of SEI's Advisors' Inner Circle Funds, announced in August that it would liquidate in September. The Avatar Advantage Equity Fund and the National Asset Management Core Equity Fund, which both operate under U.S. Bancorp's Advisors Series Trust, both announced their intent to liquidate in mid-September.

Likewise, the management of the Schroeder Small Cap Value and the Schroeder Emerging Markets funds announced on Sept. 17 that it would pull the plug on these funds in October.

While most experts point to small, unknown funds with less than $25 million to $50 million in assets as the most at risk of closing their fund doors, some highly successful funds' managers are also calling it quits.

On Sept. 13, for example, the $33 million no-load Atalanta Sosnoff Fund, the sole mutual fund managed by Atalanta Sosnoff Capital Corp. in New York, notified shareholders that it would close its six-year-old mutual fund's doors at the end of the month. Despite the fund earning a coveted four-star rating from Morningstar, the fund's advisor chose to shut down the fund and focus, instead, on its separately managed accounts.

In a letter to its investors, company executives explained that the increased costs of regulatory compliance, coupled with the fund's small size, had made continued operation of the fund uneconomical. A request for comment was not returned.

While there hasn't been a flood of small fund shops padlocking their doors, there could be an uptick in this activity next year, as fund advisors gear up by Jan. 16, 2006 to comply with the new SEC rule requiring funds to have independent board chairman, said Bob Dorsey, managing director and co-founder of Ultimus Fund Solutions, the Cincinnati fund administrator. Beyond that, "many independent board trustees do not want to step into the role," Dorsey explained. The chairman title requires more of a time commitment and added responsibilities.

Distribution concerns are also fueling fund closings and outright adoptions. "People are moving to fund adoptions from a distribution stance," said Paul Schaeffer, head of strategy and innovations for the mutual funds group of SEI Corp.

"In many cases, funds underestimated their broker/dealer distribution network or misjudged their in-house distribution," Dorsey agreed.

"Distribution is still the key," Neuberger said. If a fund manager can still manage money but find someone to adopt them, then they will gladly stay on as sub-advisor. On the flip side, he continued, it's not just small funds seeking a parent. Somewhat larger funds have been inquiring about funds to potentially purchase to rapidly double assets, he said.

Early this year, three mutual funds managed by Cooke & Bieler of Philadelphia, previously under SEI's Advisors' Inner Circle series trust, were adopted by Wells Fargo. And just last week, the board of the Thompson Plumb Funds of Madison, Wis., approved the adoption of two of its four funds by Dreyfus of New York.