When Putnam Investments announced that it was cutting its retail fund lineup from 66 to 55, it was not very surprising to industry analysts given the market conditions over the past two years. What was somewhat surprising, however, was which funds the firm decided to get rid of. Instead of closing large funds with poor performance records, Putnam proposed to merge small, overlapping funds and new funds that never really had an opportunity to prove themselves.

"Their consolidation and elimination of funds is not a surprising thing to me, nor should it be surprising to anyone," said Mark Lane, an equities analyst who covers Putnam's parent company Marsh & McLennan for William Blair & Co. of Chicago. "We've just come through an extremely strong upturn, through the end of 1999, of the growth equity sector, an area where Putnam has had a lot of success. I think it's a very natural process to go through."

Although it may be natural, cutting this many funds at one time is something the Boston-based fund company has never done before, according to Matt Keenan, a spokesman for the firm. The firm is proposing to liquidate its Preferred Income Fund and merge 10 retail equity funds and 10 incubated funds that never were made available to the public (see accompanying chart for proposed mergers)

Overlap as the Impetus

However, the number of funds cut may not be as important as which ones the firm chose, according to analysts.

"The first thing that surprised me was that most of the liquidations are related to overlap, versus performance related," said Kelli Stebel, equity fund analyst at Chicago-based Morningstar.

When Stebel first heard that Putnam was considering cutting funds, she immediately thought that the Putnam OTC Emerging Growth Fund would be the first to go. Although the $1.65 billion fund had a return of nearly 130% in 1999, it lost 51.3% and 46.1% in 2000 and 2001, respectively, giving it a three-year annualized return of -18.33%, ranking in the 99th percent in its category, according to Morningstar.

Instead, the firm decided to streamline its products and merge similar funds. For example, the Putnam Balanced Fund is being merged into the George Putnam Fund of Boston, both of which are managed by Jeanne Mockard.

"They're basically the same fund. When I go over them with Jeanne, we do them both at once," Stebel said.

Throwing Back Small Fish

In addition to merging similar funds, Putnam is merging funds that were popular a few years ago, but have fallen out of favor. However, of all of Putnam's funds that have experienced poor performance of late, only small funds that also had some degree of overlap with larger funds were chosen, according to Stebel. The firm's bigger funds, even those with poor performance, were left alone. The Putnam New Century Growth Fund, the Putnam Technology Fund, and the Putnam Preferred Income Fund are examples of the funds for which the investment rationale has diminished, according to Keenan.

"Investors in the 1990s continually sought new and different fund products, but the markets and industry have shifted," Lawrence Lasser, Putnam's president and CEO, said in a statement.

The fact that only small funds were among those selected to be merged is surprising, Stebel said. The 11 funds that would be merged or liquidated hold roughly $5.2 billion or roughly just 3% of Putnam's total retail assets as of the end of February, according to the firm. Stebel believes it may have made more sense for the firm to get rid of some of its bigger funds that have not performed well.

"That's the key element; they're all smaller funds," she said. "I thought that was surprising. The New Century Growth is now being merged into the Putnam Voyager fund, which hasn't had stellar performance either. What are the shareholders actually getting? I thought they would try to bury the records of some of their biggest funds."

Spring Cleaning?

That need to pare fund lineups has affected the whole fund industry, not just Putnam. A certain amount of volatility that causes a fund firm to cut funds that have fallen out of favor is a healthy process for a firm, Lane said.

"Every fund family, especially a large one, comes across that problem," Stebel said . "It's a kind of spring cleaning. In good times you come out with a bunch of funds, and then a couple of years later you ask, Why did we open that?'"

Still, because of the prolonged down market, the past few years were not a good time to test a fund's long-term investment philosophy, Stebel said. For example, the New Century Fund, which was created in January of 2000, never had a chance to get off the ground.

"It's been an inauspicious time for aggressive growth. The New Century was not able to get its mutual fund legs," Stebel said. "There was never a favorable market around for that fund."

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