Since the start of this year British fund groups have closed or merged away nearly 200 retail funds in a trend that is symptomatic of continuing market weakness. This compares with the 83 products that groups have launched so far this year.
But is the disappearance of small funds good or bad news for investors?
Looking at the figures in more depth, it is clear that over 2007 and 2008 the number of fund closures rose steadily as the financial crisis took hold and product providers tried to cut costs.
In 2007, 136 funds closed; of these, 92 were liquidated and 44 were merged. Last year, 175 funds fell victim to the credit crunch, with 130 of these being merged and 45 closed outright, according to Morningstar data.
On the face of it, fund groups rationalising their product ranges could be seen as creating a win-win situation for investors as well as for the groups themselves. Smaller funds are often the ones that consistently underperform, and investors or their advisers stay put either because they are apathetic or they do not want to pay switching fees.
However, when funds are merged away, investors may end up in a product that does not meet their needs.
Chris Traulsen (pictured), the director of fund research at Morningstar Europe, has criticised the industry’s propensity to launch trendy funds as a way to increase their assets as quickly as possible. He says the fund closure figures are close to what he would have expected, given market conditions and the fact that groups have been consistently rolling out new funds in the past few years.
This trend towards “short-term asset grabs” was not sustainable, says Traulsen.
Morningstar tracks more than 50,000 funds across Europe.
The sheer number of vehicles in the industry indicates that there is “too much product chasing too little money”, Traulsen argues. “There is too much of a focus on marketing rather than the investment craft on the part of some fund groups. They should be rethinking the funds they offer.”
Groups should focus on the end investor rather than try to gather assets any way they can, Traulsen adds.
He says that as times have become tough groups have merged away funds to serve their own interests without considering the impact on the end investor.
“Fund managers are doing this to benefit their businesses, because they say it costs too much to run small funds, or they are taken over by another company and they don’t want to have two similar product ranges,” he says.
“For investors, one risk is getting stuck in a merger situation with an offering that is not suitable for you. It can change your asset allocation, you may have to pay switching charges, and you could end up with a costlier fund. Essentially a fund group is choosing another group for you when they change the fund manager or move the fund.”
Traulsen recommends investors do their own due diligence and research before allowing themselves to be steered into a different investment product.
When a fund is liquidated there are other issues involved. “People could front-run it because they know the manager is selling everything,” Traulsen says. “You don’t want to be the last one in a fund. Then there are reallocation issues – you have a cash allocation and you have to do something with it.”
But the groups argue they do take measures to ensure mergers and closures are in the best interests of shareholders.
Gartmore, for example, says that in such situations it goes above and beyond the legal requirements incumbent on fund groups. In the first instance, all fund mergers have to be deemed appropriate by the depository and the Financial Services Authority.
Then shareholders are given pre-notification announcements at least three months before the expected merger date.
“This is not statutory but our way of giving distributors and investors plenty of notice,” says Gartmore. It is a requirement that investors get at least 14 days’ notice of an extraordinary general meeting where they can vote for or against the plans.
“At any point during the communication process shareholders can also vote with their feet by selling or switching,” the group says.
The issue of fund size is also important. Neil Woodford of Invesco Perpetual, arguably Britain’s most popular fund manager, manages about £19.2 billion in total. In America, a single fund called the Growth Fund of America has $143 billion (£87 billion) of assets.
Traulsen says it is not necessarily desirable to have such enormous funds, partly because of liquidity problems, but on the other hand few British funds have enough assets to benefit from economies of scale.
“There are few, if any, contracts in Europe that specify the fund house will reduce its management fee as a percentage of assets as the fund grows in size,” says Traulsen. “This is more than a little silly – asset management is extremely scalable, and costs don’t go up by nearly as much as fees when assets grow, so profit margins expand rapidly as assets under management increase on a fund.”
The reason lower fees are not always set in accordance with the size of the fund is that in Britain the authorised corporate director can be the group itself, so it can raise fees as and when it likes. “The assumption is probably that shareholders can go to a different fund if they don’t like it, but given switching costs and lack of investor education on the topic of fees, as well as an incentive for advisers to obtain a trail commission, the reality is quite different,” Traulsen says.
The trend towards consolidation looks set to continue into 2010. Morningstar estimates that by the end of the year the industry will have seen about 278 fund closures. Traulsen says he would like to see more consolidation. “I hope it carries on into next year as there are still too many funds out there,” he says.