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Survivor: Fund Liquidations in 2001
hile it takes a majority vote to kick out a contestant from the Australian Outback, the mutual fund industry doesn't operate with such democracy. Contestants vote themselves off by shutting down their ailing funds in what is known as a "fund liquidation." Predictably, fund companies do not opt to kill funds just to end the streak of losses, but rather because paltry performing funds typically lack enough assets to operate profitably. Wiesenberger estimates the profit zone for mutual funds to be in the range of $25-$50 million in assets. Of course, this is not to say that all laggards are prone to shut down nor does it suggest that all small funds will vanish. Many mutual funds with heart-breaking performance records continue to exist so long as they attract and retain enough assets. And many very small funds remain afloat for years simply because their families can afford to operate them unprofitably. But regardless of why fund liquidations happen, the outcome to shareholders is undoubtedly painful. Last year, a record 225 funds were liquidated, topping the previous record set in 1998 when 222 funds shut down. Year to date, through the end of the first quarter, another 40 funds joined the liquidation club and set the stage for what could potentially be another record year for fund liquidations.
Table 1.1
History Of Liquidations In The Past Decade
Year
|
Liquidations
|
|
1990
|
33
|
|
1991
|
40
|
|
1992
|
9
|
|
1993
|
12
|
|
1994
|
52
|
|
1995
|
156
|
|
1996
|
170
|
|
1997
|
141
|
|
1998
|
222
|
|
1999
|
166
|
|
2000
|
225
|
|
YTD
|
40
|
|
The YTD period is as of 03/31/01
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Evolution or Revolution?
In 2000, the wave of fund liquidations did not raise as many flags as it does today. For one, the market's downturn, albeit dramatic, was not yet confirmed to be the work of a slowing economy. The major indices were still carrying much of the staggering gains made in 1999 and the early part of 2000. Fund inflows remained strong and, in fact, posted a record $400 billion for the year. Even Wiesenberger's report on fund liquidations at the end of the third quarter attributed the rise to the fierce competition in the fund industry and not necessarily to the market's woes. But today, with the market crash entering its 13th month, it would be too forgiving not to ascribe the liquidation mania to the bears. Those very same bears who forced the fund industry to introduce only 55 new funds to the market in the first quarter of 2001, down from 255 funds in the same period a year ago. The same bears who triggered the first official month of net outflows (February 2001) from equity funds in many years. The same bears who made Cisco announce its first layoffs ever and AT&T cut its dividend for the first time. And while 40 liquidated funds do not a trend make, it may help to know that at the same time last year, only 35 funds had been shut down. In the three quarters that followed, the figure rapidly climbed to 225 liquidations, effectively setting the new record. The point is, the picture is much bleaker today than it was last year and hence' there are compelling reasons to make us believe that more liquidations are on the way. But predicting future liquidations is not our goal here, although we seem to have done it successfully last year. Rather, we are attempting to analyze the cause of this phenomenon and possibly suggest measures that fund investors can take to avoid being victims of this dreaded occurrence.
The Analysis
It may seem self-contradictory to do so, but to understand the forces behind liquidations this year, we have to examine the trailing five quarters (taking last year into account.) And now that we view last year's liquidations in a more realistic, less optimistic light, this year's first quarter liquidations should be a continuation thereof. Shown on next page is a breakdown of the various fund categories in which liquidations were at their highest:
Table 1.2
Fund Categories With The Highest Liquidations
Fund Category
|
Liquidations
|
|
1
|
International
|
43
|
|
|
Latin America
|
11
|
|
|
Diversified Emerging Market
|
11
|
|
|
Diversified International
|
10
|
|
|
Asia Pacific
|
6
|
|
|
Europe
|
5
|
|
2
|
Large Cap
|
35
|
|
3
|
Global
|
24
|
|
|
Global Income
|
17
|
|
|
Global Equity
|
7
|
|
4
|
Muni Bond
|
15
|
|
|
Muni Single State
|
13
|
|
|
Muni National
|
2
|
|
5
|
Small Cap
|
15
|
|
6
|
Real Estate
|
12
|
|
7
|
Mid Cap
|
11
|
|
8
|
US Government Bond
|
10
|
|
9
|
Market Neutral
|
8
|
|
10
|
Corporate High Yield
|
8
|
|
11
|
Internet
|
3
|
|
For the period between 2000 and Q1 of 2001
|
It seems that International Funds bore the brunt of the turmoil, and unsurprisingly so! Given the high correlation of international markets to that of the US, it comes as no shock that these funds were hit equally hard. However, many of these regions fell down for their own good reasons too. In fact, each of the five international categories: Latin America, Europe, Asia Pacific, Diversified International and Diversified Emerging Markets trailed the S&P 500 for the period shown above, evidence that their demise was due to factors bigger than the US woes. The lack of strong political reform, failure of capital restructuring and illiquidity were some of the forces that weighted heavily on these markets. Poor returns coupled with sizable asset outflows forced many of these once-highflying funds out of the game.
Although the Large Cap Fund category is a close second in this list, the number of liquidations from this group is relatively low given that some 1,600 funds reside in the group (Of note, Wiesenberger does not make the distinction between growth and value funds.) But examining the 35 individual funds that shut down, it seems that the majority of them were laggards with very little assets and mostly from mediocre fund families. Names such as Forum Investors Growth and Memorial Value were some of the unrecognizable names that we came across. Curiously enough, the average tenure of these 35 funds was a mere 11.2 months. Those findings suggest that these funds' final chapter was brought primarily as a result of their weak brand name and to a much lesser degree, as a result of the bearish forces that affected the entire universe!
Make no mistake, however, the Fixed Income funds that shut down were inarguably the result of low assets and not the lack of strong marketing. The average asset base for the 50 bond funds that shut down was a tiny $5.8 million at the time of liquidation. To be sure, the universe of fixed income funds has been experiencing asset outflows for extended periods of time, albeit reversing course this year in terms of both inflows and performance. Notably, the Muni Bond category has been on a redemption spree for the past three years and consequently, was hit the hardest with a total of 15 liquidations. Of note, the Heartland debacle doesn't seem to have kicked in yet and no Muni High Yield Bond funds showed up on our list. Predictably, the three Heartland's funds in questions didn't show up either, as they are currently under custodianship and yet to be liquidated.
Remember Internet Funds? Well, we're trying to forget! Three of the 39 Internet funds that existed at the beginning of the year are now history and many more seem to await the same unfortunate fate. Zero Gravity Internet, De Leon Internet 100 and Internet Index Fund were all shut down after a very brief history in the market. Curiously enough, however, no technology funds were shut down this year or last. This is not a big surprise given the unprecedented assets they have accumulated during the days of the bulls, both from capital appreciation and new inflows. But that may not remain to be the case for too long. Three of the 210 Technology funds that Wiesenberger tracks are originally Internet funds that changed their names for obvious reasons. The Wescott Nothing But Net Fund had nothing better to think of but change its name to Wescott Technology Fund. Its fellow peer Monument Internet Fund was renamed to Monument Digital Technology Fund and the former Investors Capital Internet Fund is now the better-sounding Investors Capital Internet & Technology Fund. Wescott and Investors Capital couldn't change one thing, though: the fact that their assets are currently $700 K and $100 K respectively! If history has taught us anything, it's that these two funds are potential entries for our next report on fund liquidations.
In the Introduction section of our Fund Liquidations report last year, we referenced the then-beleaguered Legg Mason Market Neutral Fund as a notable example of a promising fund going bust. While this is not as newsworthy today, what's real news is that three more Market Neutral funds have also shut down (a total of seven funds, when taking multiple share classes into account.) The Dreyfus Premier Market Neutral, Puget Sound Market Neutral and Warburg Pincus Long Short Market Neutral all liquidated their portfolios after failing to capitalize on up markets or profit from down ones. Here's a flash: timing the market is indeed impossible! Four funds out of a group of 12 failed to do it. The remaining eight funds are shown below:
Table 1.3
Market Neutral Funds (Data as of 03/31/01)
Fund Name
|
Return YTD
|
Return 2000
|
Net Assets ($MM)
|
|
AXA Rosenberg SS Market Neutral
|
6.07
|
-9.74
|
11.85
|
|
AXA Rosenberg Val Market Neutral
|
8.86
|
0.66
|
65.5
|
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Calamos Market Neutral Fund A
|
3.57
|
10.28
|
63.83
|
|
Franklin U.S. Long-Short
|
-1.56
|
55.08
|
477.21
|
|
Linder Market Neutral INV
|
-4.34
|
12.07
|
23.51
|
|
Merger Fund
|
1.1
|
17.58
|
1,202.70
|
|
Montgomery Global Long-Short R
|
-14.06
|
-24.33
|
120.98
|
|
Phoenix-Euclid Market Neutral
|
4.49
|
1.77
|
23.6
|
Players
Fund liquidations are not limited to small or mid-sized fund firms. At the time of publishing, Vanguard Funds, the nation's second biggest fund family, announced that it's pulling the plug on two of its funds, Global Asset Allocation and Preferred Stock Fund. The fund giant decided that both funds, each with over $100 million in assets, were confusing to investors and did not offer a logical fit in their portfolios. Which is probably true, but it is also very safe to assume that profit, or the lack thereof, was a bigger force in making this decision. Although funds from bigger fund families can reach profitability faster as they spread their costs over more offerings, the list of fund liquidations is always filled with big household names. Below is a ranking of fund families with the most liquidations.
Table 1.4
Fund Families With Highest Liquidations
Fund Family
|
Liquidations
|
|
Dreyfus Premier
|
23
|
|
Aetna
|
16
|
|
Kemper
|
15
|
|
Prudential
|
14
|
|
Mitchell Hutchins
|
12
|
|
Van Kampen
|
12
|
|
FundManager
|
11
|
|
Munder
|
10
|
|
UAM
|
10
|
|
Scudder
|
6
|
|
For the period between 2000 and Q1 of 2001
|
Check List
From poor performance and declining assets to weak brand name and unsound offerings, the reasons for fund liquidations are so vast. But without a doubt, the current market downturn seems to be the main culprit behind this wave of liquidations. For investors, it is easier to understand why a certain fund shut down than it is to foresee the next suspect. The warning signs are numerous, however, and should at least serve as an early alarm to apprehensive investors. Specifically, investors should pay close attention to the following variables:
a - Low asset base: A fund with consistently declining assets is very prone to being shut down. There is no clear-cut threshold as to what asset level is dangerous. Examining the asset size of the funds that have shut down in the past few years shows a very mixed picture. But investors should evaluate the fund's size in relation to other competing funds or funds from the same fund family.
b - Consistent lackluster performance: Poorly performing funds are obviously more susceptible to undergoing a liquidation than better performing funds. Investors should avoid getting into, or holding to, funds with bad performance records in the first place.
c - History of liquidations: While the famous disclaimer states that past performance is not indicative of future results, this may actually hold true when it comes to liquidations. Fund investors can check the Press Release section of the fund company's web site to check for prior liquidation announcements.
d - Size of the fund family: As mentioned earlier, bigger fund companies can afford to maintain an unprofitable fund to avoid bad publicity. Investors should evaluate the fund company's relative name and strength if the above criteria are also in question.
e - The category's overall performance: While some fund liquidations are due to factors specific to the fund itself, most liquidations are a result of the conditions of the overall sector or category to which the fund belongs. Unlike stocks, beaten-down funds may never live long enough to stage a comeback, if the pressure is primarily broad-based or sector-based.
Conclusion
All in all, investors should always use caution when evaluating any mutual fund, for fear of liquidation or to gauge performance. Investors should avoid funds with poor performance records all together. But for the industry itself, it may be better that, in theory, only the strongest survive. Years of rapid growth and increased competition have reshaped the industry into a Darwinian model of survival of the fittest. The funds that are not fit, will quickly become extinct to investors. This process of natural selection will serve as the decisive ruler making some funds dissolve, while others evolve. In the end, the ones that survive, may very well be…. the best of breed.
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Sponsored by James J. Eccleston. This Web site contains material of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
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