With the shift from a bull market to a bear market in the past two years, many fund companies have been left holding funds that are relics from a bygone era. With a new emphasis on the bottom line, firms are increasingly merging or liquidating funds that they couldn't churn out fast enough two or three years ago.

In fact, Thomson Wealth Management, formerly Wiesenberger and a division of Thomson Financial, the publisher of MFMN, recently released data showing the level of fund mergers climbed to an all-time high of 372 last year. The reason? Low levels of assets coupled with poor performance have been a drag on fund complexes' profits, said Ray Amani, director of Thomson Wealth. As a result, firm's are culling the small, poorly performing funds out of their lineups and either merging or liquidating those funds, he said.

Last year, 785 fund share classes were merged, compared to 594 the previous year. And funds and share classes that were liquidated entirely were also up, but did not hit record levels, according to Thomson Wealth. There were 144 funds that were liquidated last year compared to 160 the prior year and 204 share classes were eliminated compared to 257 in 2000, according to the data.

The numbers are even more dramatic when taken in historical context. From 1991 to 1995, on average there were just 50 funds liquidated each year. Since that time, however, the annual average has increased to 137.

Much of that activity reflects the growth of the fund industry, which is now nearly saturated with approximately 13,000 funds, and changing investment preferences, Amani said. Typically, the funds that are merged out of existence are those funds that have two or more quarters of poor performance and low levels of assets under management, he said. "Any time you have total assets of $100 million or less, the economies of scale go away," Amani said.

But just as many firms have been busily cutting back on their fund lineups, many others are adding new products, according to Investment Company Institute data, which shows a steady overall increase in the number of funds available to investors. From 2000 to 2001, there were a total of 156 funds added to the industry, raising the total number tracked by the ICI to 8,321. That number is up from 7,791 in 1999 and 7,314 in 1998, according to the data.

The ongoing growth of funds is a problem because the fund industry is oversaturated with product as it is. However, merging or liquidating a fund is not without consequences, he said. Oftentimes, the fund that is merged is forced to significantly alter its investment objective, he said. That can wreak havoc on investors' portfolio allocations, he said.

Moreover, merging or liquidating funds can jeopardize a fund company's relationship with financial advisers, said Ric Edelman, CEO and founder of Edelman Financial Services, an independent financial planning firm. "There is a potential downside if a portfolio is liquidated and you wind up with capital gains and you have to reinvest the assets," he said. Also, if a planner is happy with a portfolio manager's stock-picking abilities, but their fund has to be merged or liquidated out of existence simply because the manager was not a good marketer, many planners react negatively, he said.

Worse still, if an adviser wins the confidence of a client and talks up a particular fund, the relationship could be seriously damaged if the fund disappears after the adviser sinks his or her client's assets in the fund. "The client could lose faith in the adviser and call into question the adviser's skill in fund selection," he said.

Moreover, such scenarios have damaging consequences on the relationship between the adviser and the fund wholesaler and could result in lost business, he said. The key to protecting against that situation is communication. If a fund company regularly updates advisers on what its plans are, the adviser can than react in a timely way. The key, Edelman said, is giving the adviser enough forewarning of impending mergers and liquidations. And if it's done properly, fund wholesalers can retain those assets and improve their relationship with the adviser, he said.

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