In general, when a fund company merges two funds together, things are not going well with one of them.

The problem, however, may not be the admission of turbulence, but rather the negative affect of the actual mergers. Fund mergers can spark outflows even if the company really believes that shareholders are better off as a result of the merger, according to industry analysts.

Recently, there seems to have been a greater urge to merge. There were 501 fund mergers in 2000, the most ever, according to Weisenberger, a division of Thomson Financial, (publisher of MFMN). As of the end of July, there were already 346 fund mergers, more than at this time last year and on pace for nearly 600 by year-end. Compare that to 1996, when there were only 59 fund mergers for the year.

Companies do not always merge funds because things are not going well. One of the main drivers of fund mergers is asset management company mergers, according to analysts. When two fund families merge -- usually through an acquisition -- there are often duplicative offerings and as a result, firms will combine them. While that was a significant reason for fund mergers in 2000, it is not this year as M&A activity among asset managers has slowed significantly, according to Ramy Shaalan, a Wiesenberger mutual fund analyst.

The companies that have merged the most funds this year have done so in-house, according to Shaalan. The major example is Zurich Scudder's merger of the Kemper and Scudder funds this year. Other companies include; Prudential, Paine Webber, Pilgrim and Merrill Lynch.

Of course, the other main reason for mergers is poor performance. Funds that suffer greatly become difficult to sell. Also, often a falling market will bring asset levels lower than a company wants or needs to sustain the fund as a profitable business. Merging the fund may likely be the result. This year, most fund mergers are performance related, according to Shaalan.

The number of fund mergers due to poor market conditions has been heightened because of the prosperous conditions beforehand, according to Donald Cassidy, senior analyst at Lipper. The soaring market before the downturn caused many companies to bring out funds that had short-term success, but not necessarily long-term potential -- such as the many technology and Internet funds that were started up. "One of the big things has been the burst of the Internet fund bubble," said Paul Herbert, an analyst with Morningstar.

Monument Funds Group, Strong Investments and Merill Lynch are examples of companies of varied sizes that have merged their Internet funds this year.

"It's cyclical," said Cassidy. "We went through a tremendous time from 95/'96 through last year where companies thought the sky's the limit and you could sell anything. Now, in tougher times, companies that brought out some of those specific funds started to say, Oops. This isn't going to perform very well.'"

Also, as margins are increasingly pressured during the downturn, weak funds may be merged into others simply to consolidate costs and leverage economies of scale in the management of those assets, according to Shaalan. "Sometimes a fund in isolation is simply not profitable enough," he said.

Law Of Unintended Consequences

Merging a fund, however, could cause a firm to lose assets altogether in its attempt to manage them more cost efficiently. "That is a major worry for companies and it's a hard one to control," said Cassidy. If it can be avoided, it is never a good idea to give investors any reason to leave a fund, he said. While the announcement of a merger might scare some assets away, it is not at all likely that it will trigger any inflows.

Outflows due to mergers are more likely when it brings about a change in manager or investment objective, according to Cassidy. "It matters more if you're giving the investor something different," he said. "If you're moving the Internet fund into the technology fund, there will be some people who will leave because they wanted a strictly Internet funds, but many won't care."

Another major reason why mergers can trigger outflows is that with a merger there often comes significant tax repercussions, according to Shaalan. Upon hearing of a merger proposal, some investors may bail out of the fund simply to avoid those, he said.

Retail investors are the least likely to remove assets because of a merger, according to Cassidy. "With broker-sold funds, any event is a reason to call the client to talk about possibilities," he said. "And if it's advisor-sold, there's going to be more attention paid there. Advisors are looking more closely at the fund and it's asset allocation, and a change in that may prompt the removal of assets."

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