More funds fall – or emerge reinvented

Putnam Investments surprised some of its investors last week, when it announced the scuttling of 11 of its 66 funds. Ten of the funds will be consolidated into other Putnam funds. One will be scrapped.

The 11 funds account for about 2.4 percent of the some $300 billion under management at Putnam, the fourth- largest mutual-fund company in the United States.

The fund cutting by Putnam, a unit of insurance broker Marsh & McLennan, is the latest in what has been an industrywide effort over the past few years to reduce the number of mutual funds on the market, according to experts.

"The fatality rate for mutual funds has been rising, and more cutbacks can be expected," says Russ Kinnel, who heads up equity analysis for information-firm Morningstar Inc., in Chicago.

"Beyond the issue of what has happened at Putnam," Mr. Kinnel says, "the consolidations provide a rare peek into what has been happening within the mutual-fund industry in the past few years."

Simply put, he says, the industry has overexpanded, reflecting the ebullient US economy and booming stock market of the late 1990s.

"Some of the new funds were quite good, but so many were launched that it was almost impossible for all of them to make good financially," Kinnel says. "Many were just duplicatory of other funds, and some, frankly, were just trendy garbage."

While Putnam's announcement is somewhat dramatic, plenty of fund companies have pruned away funds over the past few years (see chart, above right).

Fidelity Investments, which has created more funds than any other fund group, cuts back a fund every now and then, usually to little public fanfare. In January, for example, Fidelity International Bond Fund merged into the company's strategic income fund.

Last year, the only merger involved a money-market fund.

More recently, Investec's Asia Focus Fund absorbed the smaller Asia New Economy Fund, And USAA decided to merge its small USAA Income Strategy Fund with the larger USAA Income Fund.

Since 1999, some 1,762 funds have disappeared either by liquidation or by being merged into other funds, according to Morningstar.

"One major reason for the disappearance of funds is the increasing cost pressure within the mutual-fund industry," says Tim Schlindwein, who heads up investment-consulting firm Schlindwein Associates, in Chicago.

Typically, smaller funds – such as those with less than $100 million in assets – tend to have higher administrative expenses than larger funds, Mr. Schlindwein says.

Still, size is not the only reason fund companies eliminate funds, experts say. Sometimes fund managers wants to hide poor-performing funds that tend to drag down the performance averages for an entire fund company.

In Putnam's case, performance of many of the scuttled funds was lagging.

"It is not surprising that funds are [being] closed, especially in the culture of companies such as Putnam," says Michael Lipper, a longtime fund expert who heads up Lipper Advisory Services, in Summit, N.J.

Putnam, like several other companies within the industry, was always creating new funds, Mr. Lipper says. At the other extreme, some companies seldom create new funds.

One example: Dodge & Cox, which last year introduced its first new fund in 17 years, says Lipper.

Mr. Lipper, for his part, does not view consolidation as necessarily bad. "We can expect to see more closings, consolidations, and mergers. This is a good thing," Lipper says, equivalent to the act of pruning by a gardener.

The funds that remain tend to be stronger and better focused, he says. And that, in turn, means better performance for investors.

While the slow economy and falling stock prices over the past several years have been especially stressful for fund companies and investors, Lipper believes recovery is in the air.

As the economy slowly rebuilds, he expects huge amounts of cash in money-market accounts and bank certificates of deposit to shift back into equities, he says.

Ironically, many of the best options for growth-oriented investors may have been among the slow-performing funds now being closed within the industry, Lipper notes.

When it comes to individual stocks, investors love bargains – good companies that have watched their share prices slide, he says.

But when it comes to mutual funds, he notes, the reverse seems to hold true. Investors want to buy the hot-performing funds, even though they may actually have peaked.