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O.K., let's say you invested some money in a mutual fund and all of a sudden you get a notice in the mail that it's being liquidated. What's going on? What should you do? And how could you have avoided getting into that situation in the first place?
Those are questions increasing numbers of investors have been asking themselves lately. With 11,000 offerings for investors to choose from, the mutual-fund industry is more competitive than ever. And more of them are liquidating and returning money to investors because their managers couldn't beat the market or attract enough assets to keep a fund growing.
Niche players tend to be prime candidates, including pure real estate and short-term corporate fixed-income funds, as well as emerging-market funds introduced in 1998 during the Asian financial crisis. These portfolios have racked up big losses this year, leading to waves of redemptions that have drained their asset bases.
THE WARNING SIGNS. For investors, a mutual-fund liquidation can be more than inconvenient: Shareholders often end up getting less money than they paid in. On top of that, they may get whacked with a capital-gains tax bill come January -- if the fund sold profitable stocks early in the year. That means investors should pay close attention for signs of a looming liquidation.
Some harbingers include poor performance only a year or two after a fund's creation, weak asset growth, a changing investment focus, or perhaps too much concentration in a single sector that has been especially hard hit. Investors should watch for these signs because funds aren't required to provide much notice of liquidation plans.
Shifting assets to a more stable fund may not be that difficult, either, given that how many funds are available and how strong the category in general remains. "No one is saying the fund industry is shrinking -- at least not in terms of size," says Ramy Shaalan, a mutual-fund analyst for Maryland-based Wiesenberger Thomson Financial, which compiled a liquidations report on the industry this fall.
RECORD MORTALITY. Still, 176 funds liquidated their assets to shareholders in the first three quarters of 2000, according to Wiesenberger Thomson. Most struggled for several months before finally throwing in the towel. By yearend, liquidations will likely break the record set in 1998, when 222 funds closed.
Big-name fund families aren't immune to the trend. Consider the Legg Mason Market Neutral Trust. It was supposed to beat the market in good times and bad, but it shrank from a high of $19 million in assets in the summer of 1999 to just $6 million this spring. The fund, which is technically a hedge fund because it made modest derivative bets, gambled too early on the decline of Internet stocks, the company says.
After 20 months in existence, it closed at the end of September, with shareholders given checks worth about 80% of their initial investment. "For this fund, it was a lack of investor interest coupled with poor performance," says Legg Mason spokeswoman Alison Andrews. Legg Mason wasn't alone.
PERFORMANCE ANXIETY. Smaller, lesser-known, poor-performing funds have had a difficult time surviving, too. The tiny $2 million Victory Lakefront Fund, named after its managers' view of Lake Erie in Cleveland, liquidated in September after three years on the market. The fund was managed by the Lakefront Group, a minority-owned investment firm, with the idea of appealing to African Americans by investing in companies that have strong employee diversity programs.
"That approach didn't work," says Chris Dyer, who marketed the fund at Key Asset Management. "Then we had trouble repositioning the fund. We tried just about everything we could before finally giving up."
Liquidations suggest how the industry may be evolving. Accustomed to bull markets, investors today are ever more impatient with poor performance. Financial Research Corp. in Boston reported this year that 90% of fund assets are managed by only 10% of funds. By and large, these are the well-established families such as Fidelity, Vanguard, Janus, and T. Rowe Price. With such unequal distribution and investors' expectations at very high levels, smaller, lagging funds are vulnerable.
SHRINKING UNIVERSE. But the merger trend itself is also a big cause of liquidations. A mutual-fund consolidation wave over the past three years has intensified during 2000, prompting many merged fund companies to eliminate duplication in their offerings. While 236 new funds have been created this year, 419 have merged into other portfolios. Add to that the number of liquidated funds, and the net effect is a 359 fewer funds on the market.
That's quite a change from last year, when the fund universe expanded by 238. Says Shaalan: "All in all, it may be better for the industry that, in theory, only the strongest survive." But investors must be alert to the shift. The key is to cull out the weak funds before liquidation ever becomes an issue.
Shook is a staff reporter for Business Week Online in New York Edited by Thane Peterson
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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