Fund mergers have increased recently, and as long as the current market downturn continues, the numbers of mergers will only go up, according to industry analysts.

Last year, there were 236 fund mergers, an unusually high number, according to Lipper. This year's pace is about the same with 184 occurring so far. And the number of total share classes that have been merged this year has already matched last year's mark of 501, the most ever, according to Wiesenberger/Thomson Financial. (Thomson Financial is the publisher of MFMN.)

The nature of the mergers this year is somewhat different than in years past. Previously, fund complex mergers and acquisitions have fueled much of the individual fund merger activity; however, this year, most mergers have been driven by poor market performance and small asset size.

Many of those funds have been specific, boutique products, such as Internet funds, that were introduced when nearly all funds were seeing inflows. It stands to reason that the merging of those types of funds would eventually slow down once enough of them are gone. "At some point, clearly, those--what we call marginal funds -- will have been taken care of," said Donald Cassidy, senior analyst with Lipper.

While that may be true, analysts maintain that the fund mergers will continue, if not intensify. "I think there will be a bit of an acceleration in the fourth quarter of this year," said Cassidy. "There's a lot more consolidating to be done. There's still plenty of funds with a very little amount of assets."

In fact, of the 6,048 equity and bond portfolios that Lipper tracks, 2,026, over a third, have less than $50 million. For perspective, some in the industry have claimed that $100 million is the minimum a fund must have to be profitable.

"Funds that are very small are unlikely to survive," said Avi Nachmany, director of research at Strategic Insight, a financial services research and consulting firm in New York. "If a fund is too small, but has reasonable [size]relative to performance, that's one thing. But a fund that is too small and is being outperformed by its peers is not going to be sustainable for very long."

The longer the market continues to decline, the more of these funds will become unprofitable, Nachmany added. Also, firms that are wary of merging funds and are holding out on funds that are already unprofitable in anticipation of a market rebound, won't be able to do so forever, said Jim Folwell, an analyst at Cerulli Associates.

While asset size is a good indication of a fund's sustainability, the other funds that a company manages is a major factor of how costly it is to run a small fund, according to Cassidy.

"The profitability level can depend on what else you've got going on in your shop and how your costs are spread out," he said. "If you have one fund that's different from the others in your shop, and you need a different management team, different research, it'll have a very high break-even point." If, on the other hand, a firm runs a large Nebraska municipal bond fund and a fairly small short-term Nebraska municipal bond fund, the costs of managing the latter may be extremely low, he pointed out.

The prolonged downturn may further intensify fund mergers as companies try to cut costs in any way they can, according to Folwell. By merging funds, firms can often achieve economies of scale and reduce expenses, he said.

"There's a constant need now to focus on the bottom line and reduce expenses and merging an unprofitable fund is one way to do that," said Cassidy

While there is still lots of room for industry consolidation, Nachmany questioned to what extent consolidation is really taking place. When fund liquidations are taken into account, 326 total funds that existed at the beginning of the year that are now not around, according to Strategic Insight. However, another 272 funds have been launched so far this year, he noted.

"The process of product refinement is a continuous process," said Nachmany. "There are normal gyrations in traditional investor preferences, and so some funds close while others open."

The recent movement from growth to value funds, large-caps to small-caps, and stocks to bonds has driven fund mergers, but also has been the cause of new offerings, he said. "There's a constant adaptation of product lines."

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