March 30, 2005 — With big name mergers and acquisitions making headlines recently, mutual funds aren’t escaping the trend either. In fact, JP Morgan recently announced the official completion of the integration between JPMorgan Funds & One Group Mutual Funds, creating the largest fund merger in the industry’s history.

Mergers have been quite popular over the past few years with an amendment to the SEC’s expanded scope for mergers between funds rule 17a-8 in 2002, which permits all affiliated funds to merge, regardless of the reason for the funds’ affiliation, and requires that each fund’s board (including a majority of disinterested directors) determine that the merger is in the best interests of the fund, and will not dilute the interests of shareholders.

Fund mergers can occur for various reasons, including fund management companies joining forces to provide more diversified products to their clients or in order to target different audiences such as institutional or retail investors. Fund mergers and liquidations may also result from new fund offerings not attracting sufficient cash flow, thus preventing normal operations. Other factors that may lead to a merger include declining assets, steadily increasing expense ratios, and poor fund performance.

When struggling or poorly performing funds are merged into other funds, their track records are “lost” or disappear into the funds they are being merged into, while the track record of the existing fund remains. This results in survivorship bias, or the tendency of poorly performing funds to be excluded from studies due to the fact that they simply no longer exist, having been merged out of existence.

Once a merger is finalized, investors may face important changes, including new sales charges, fees and expenses, taxes owed on distributions, age and size of the new fund, risk and volatility, or changes in the fund’s operations, i.e., a change in manager, or to investment strategy and style. Any one of these could call for a reevaluation of the fund on the part of investors.

In 2004 alone, 479 mutual fund share classes merged into other existing funds. This figure is down from 2003, (781 mergers), and 2002 (714 mergers), but high by historical standards over the last ten years. Both 2002 and 2003 were greatly affected by the implosion of aggressive growth and emerging growth funds after the dot-com bubble burst. Many, such as Merrill Lynch Internet Strategies, were merged out of existence. More recently, fund management companies themselves are merging due to a saturated market, increased costs, and stricter regulations.

In terms of fund families last year, the greatest number of fund mergers took place among the TA IDEX funds. The family completed a total of 82 share class mergers in 2004. According to TA IDEX, 70% of the mergers were approved in an effort to reduce shareholder expenses by merging share classes with higher expense ratios into those with lower expenses.

Generally speaking, the acquiring funds performed better than the merged funds before they were merged last year, as might be expected. In fact, the acquiring funds’ 2003 average returns were 24.2%, compared to 22.6% for the merged funds. In 55% of the reviewed cases, the acquiring fund outperformed the merging fund during the same period.

For example, shareholders approved the merger of AXP Focused Growth Fund/B fund, which ended 2003 with a three year annualized loss of -21.21%, into the better-performing AXP New Dimensions Fund/B in June 2004. A change in management also followed the merger this February, when American Express expanded its team to include Michael E. Nance and Trisha C. Schuster as associate portfolio managers of the fund, alongside lead manager Gordon Fines.

Below is a chart of how various equity categories ranked before and after mergers were completed. Returns were calculated based on the one-year period ending 12/31/2003 due to short track records and subsequent mergers in 2004.

Fund Investment Style 2003 Merged Funds Average Returns (%) 2003 Acquiring Funds Average Returns (%)
Large Cap Growth

+25.8%

+25.8%

Large Cap Value

+27.1%

+27.3%

Large Cap Blend

+25.9%

+26.8%

Mid Cap Growth

+34.0%

+32.5%

Mid Cap Value

+30.3%

+21.9%

Mid Cap Blend

+29.9%

+31.8%

Small Cap Growth

+39.9%

+41.7%

Small Cap Value

+40.1%

+39.6%

Small Cap Blend

+32.7%

+42.1%

Source: Standard & Poor’s. Total returns include reinvested dividends. Data as of 12/31/03.

Contact Bob Keane with questions or comments at:bkeane@investmentadvisor.com.