There is no doubt that a rise in regulation has increased costs for mutual funds in the past few years -- to the point of pain for many small, independent fund companies. But are things bad enough to prompt these companies to give away their assets just to get out of the business?

Reserve Funds thinks so. The money-market fund giant, headquartered in New York, hopes to build up its stable of seven equity mutual funds, recently renamed the Hallmark Funds, by absorbing the assets of small, money-losing fund shops that have had enough.

"The inefficiencies and high costs of managing small, independent mutual funds have made the survivability of these funds nearly impossible," said Reserve Funds Senior Vice President Eric Lansky. His proposal: Reserve will take over the assets without making an upfront payment, though in some cases it would offer "trailing" payments after the sale. That would allow an owner to escape the legal and administrative costs of shutting down a fund, which he estimates at $75,000 and up.

"We're creating a model to enable them to exit their fund at no cost," Lansky said. Acquired funds would be folded into the existing Hallmark funds, which currently have assets of $110 million. Reserve, which created the first money market fund in 1971, also has $25 billion in money-market fund assets. The fund's founder, Bruce R. Bent, is one of the foremost names in the industry, and certainly in money market funds (see MME 1/17/03).

So far, only one fund, the $15 million Segall Bryant & Hamill Mid Cap fund, has agreed to be acquired. But that fund will continue to exist as part of Hallmark's lineup and will be sub-advised by its current manager, David Kalis, a managing director of Chicago-based Segall Bryant & Hamill. Lansky says discussions are underway with other fund owners, though no agreements have been reached.

Industry analysts are skeptical the strategy will prove attractive to small fund owners. For many of them, a mutual fund is a means of publicly demonstrating a firm's money management skills, thus attracting capital for their core business. If that objective is met, "that fund can lose money until the cows come home but they're not going to care," says East Greenwich, R.I., mutual fund consultant Geoff Bobroff.

Other industry experts say a fund can be dissolved for substantially less than Lansky's estimate of $75,000.

Fund Purgatory'

In addition, other advisory firms may be willing to pay cash up front to rescue these assets from what Lansky calls "fund purgatory."

"If [fund owners] want to get out, I hope they would talk to us," said Neil Hennessy, chief executive officer of Hennessy Advisors in Novato, Calif., which has grown from $20 million in assets in 2000 to $1.1 billion today, mostly through acquisitions. Hennessy acquired the assets of the $34.7 million SYM Select Growth fund last September in a deal worth roughly $1.2 million, or 3.3% of the acquired assets. A month later, Hennessy paid $8 million, or 2.6% of assets, to buy five funds totaling $300 million in assets from Lindner Asset Management of Chicago.

Lansky says he has identified more than 500 funds with assets of less than $50 million, the widely quoted demarcation point at which funds are said to break even, that are run by asset management firms whose core business is not mutual fund management. Many of these funds, he says, were launched from 1998 through 2000, at the height of the bull market, by investment advisors who believed they would be a lucrative supplement to their core business. Seeded with personal or firm capital, these funds were expected to ride the bull market to an impressive three-year record, at which point they would begin to attract substantial outside capital.

But the bear market depressed returns, and recent regulations mandating anti-money laundering measures, proxy voting disclosure and a chief compliance officer, have substantially raised the cost of staying in business.

"A lot of these funds are very small shops," Lansky said. They must now ask themselves: Is a mutual fund "a growing part of the business or is it a distraction?" Combined assets in these funds, he said, exceed $16 billion.

Ron Rohe, chief operating officer of Baxter Financial, which operates two mutual funds, says legal expenses more than doubled from 2001 to 2003, mainly due to the anti-money-laundering requirements of the 2002 Patriot Act. The hiring of a chief compliance officer who reports to the fund's board, a new requirement, is an unknown additional cost, "but we know it's not going to be cheap," he said.

While Rohe is considering selling one of the firm's funds, the $3.8 million Eagle Growth Shares, to Reserve, the Boca Raton, Fla.-based firm intends to hang on to its much larger, $78 million Philadelphia Fund. In fact, Baxter, like Reserve and Hennessy, is in the market for acquisitions.

"We are looking to acquire funds to increase assets under management to offset rising costs of regulation," Rohe said. "I imagine a lot of funds that are under a couple of hundred million [dollars in assets] face the same situation."

Income Stream Sweetener

Though no decision has been made regarding the seven-year-old Eagle Growth fund, Rohe says Reserve's offer is "an appealing idea." Reserve has sweetened the deal with the offer of an ongoing income stream equal to 0.3% of assets. Lansky says "trailing" payments of up to 20 to 30 basis points may be offered, depending on the assets' "attractiveness and fit."

David Landis is a freelance writer in New York who was a senior editor with The and reporter with USA Today. He has also written for Business Week and sister publication Financial Planning and can be reached at

Copyright 2004 Thomson Media Inc. All Rights Reserved.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.