BUSINESSWEEK ONLINE : DECEMBER 18, 2000 ISSUE
BUSINESSWEEK INVESTOR Where Did My Mutual Fund Go? What to do if your fund is being merged or liquidated When mutual-fund investors are confronted with poor performance, they often head for the exits. Increasingly, fund companies are doing the same. So far this year, fund management companies including Liberty and Pilgrim have pulled the plug on a record 222 funds, or one out of every 49. They do it by merging weak funds into better performers, or by liquidating a fund's holdings and returning the proceeds to investors. With the bull market in retreat after a decade in which the number of funds has nearly quadrupled, the pace of mergers and liquidations is bound to pick up. These practices allow fund families to bury offspring with poor track records and asset bases so small they are unlikely to become profitable. According to Morningstar, funds merged or liquidated this year scored in the bottom third of their peer groups when ranked on three-year returns (table). Since most funds need $100 million in assets to turn a profit, small, underperforming funds are most likely to go out of business. DREARY RECORDS. This year, the dustbin is full of bond and international stock funds. Looking ahead, floundering Internet funds might follow the tiny de Leon Internet 100 into oblivion. Down 50% this year, the fund liquidated on Oct. 30. The urge to merge is a marketing call as much as an investment decision. Sweep away bad performers, and dreary track records disappear from fund literature and databases, making fund families look better than they really are. Because three-year returns are ''a big driver of sales, if a fund is not doing well by then, it is a candidate'' for a phase-out, says John Benvenuto, a consultant at Financial Research in Boston. Mergers and liquidations are a mixed bag for shareholders. Unless you hold a disappearing fund in a tax-deferred retirement account, such as a 401(k), there will be tax consequences. Investors might find their asset allocation strategies in disarray when a fund they've been merged into follows a different path than the one they bought. On the other hand, mergers tend to funnel investors into better-run portfolios with lower expenses. Funds don't go out of business quietly or overnight, so you'll have advance warning. Indeed, before killing a fund, a company is required to get approval from shareholders and the fund's board of directors. Approval is rarely denied. Taxes top the list of shareholder concerns. When one fund is merged into another, no taxes are due. However, those transferred into a successful fund inherit a share of its unrealized capital gains. This means that when the new fund sells a winner, investors merged into the fund get a share of the capital-gains distribution. They have to pay taxes on that gain--even though they were not around when the profits built up. In assessing whether to stay or go, ask the fund company for an estimate of the new fund's next capital-gains distribution. If one isn't available, go to the fund's most recent shareholder report and find its ''realized but undistributed gains.'' If a fund had $1 a share in such gains and the merger gave you 1,000 shares, for example, you would have a $1,000 taxable gain coming your way. Compare that to what you might owe if you sold the fund before the merger. Of course, if your original fund stake is under water, sell it to reap losses with which to reduce your taxes. GET A HANDLE. Fund mergers can drive up tax bills in other ways. When surviving funds inherit stocks from defunct siblings, their managers often sell the transferred holdings. Of course, if the winners outweigh the losers, this selling would subject shareholders in the combined funds to taxes. To get a handle on what your new fund plans to do with its hand-me-downs, look in the proxy statement you will receive ahead of a shareholder vote on the merger. You can also request a statement of additional information that details what the combined fund's financial statements and holdings are expected to look like. Another problem with fund mergers is that you might wind up with something that doesn't suit your needs. If you purchased shares in the Federated Latin American Growth Fund, for example, you might not be satisfied with your recent tax-free transfer to the Federated Emerging Markets Fund (EMMAX). Indeed, the latter invests only 25% of its assets in Latin America. Still, mergers can bring some good news. According to Morningstar, shareholders in funds merged this year saw their costs decline by 8.2%, on average, as they were funneled into larger funds with greater economies of scale. Most mergers also channel investors into better performers. The Liberty Newport Global Utilities Fund, for instance, has a three-year annualized return of 14.7%. That's about twice the 7.3% earned by the fund it is taking over, Liberty Newport Global Equity. The two funds are slated to merge in January as part of a consolidation at Liberty, which is merging 17 of its nearly 100 funds and liquidating four. Still, if a merger leaves you overexposed to one type of investment and underexposed to another, sell it and buy one that better suits your needs. Indeed, shareholders in Liberty Newport Global Equity who stay put will have a much larger exposure to utilities--31%, vs. 4.4%--than they may have bargained for. Of course, when it comes to liquidations, selling is the only option. But because these funds are laggards, shareholders frequently reap losses with which to reduce their taxes. In a liquidation, bail out fast to avoid getting caught in a fire sale. When funds that specialize in thinly traded securities such as small-caps sell in bulk, they unleash a wave of sell orders that can drive stock prices down. This undermines their ability to secure fair prices. Even before a liquidation is announced, it is possible to detect signs that a fund is on the way out (table). Small funds with a history of poor returns are most vulnerable. So are those hit by shareholder redemptions, says Morningstar analyst Matthew Gries. To be sure, not all funds that go out of business are in trouble. Mergers between fund companies frequently result in the elimination of overlapping funds. For instance, this year, Citigroup (C) is folding several CitiFunds into its Smith Barney lineup. Still, stars are rarely killed off. So if your fund company is throwing in the towel, maybe it's a sign that you should, too. By ANNE TERGESEN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Where Did My Mutual Fund Go? TABLE: Traits of Vanishing Funds TABLE: Warning Signs INTERACT E-Mail to Business Week Online

Copyright 2000-2009, by The McGraw-Hill Companies Inc. All rights reserved. Terms of Use   Privacy Notice