Flow of New Funds Slows to a Drip

The fund business is getting tougher, and that's good news for you.

Amid shriveled returns and sales, the pace of new mutual fund launches last year fell to its lowest level in more than 20 years. The number of mutual funds rose by just 165, according to the latest figures from the Investment Company Institute, the fund industry's largest trade group. The modest uptick underscores the glut of funds out there, the maturing industry's consolidation and flagging interest in funds after two tough years for stock investors.

This trend shouldn't rattle fund investors, however. As we said in a November column, Main Street investors will only benefit from heightened competition for their money. Of course, the news isn't as good for the fund managers who will inevitably find less demand for their services.

Man From Atlantis

The shrinking number of new offerings is no doubt related to the ocean of funds already out there. At the end of last year, there were than 8,300 stock, bond and money market funds, more than double the total 10 years ago, according to the ICI. And the slimming trend should continue because more than half of those funds are stock funds, which haven't seen the same winnowing as bond funds.

Paring Back Consolidation and a lousy market have slackened the flow of new funds

Source: Investment Company Institute.

The stock-fund ranks rose by 343 last year to stand at more than 4,700, while the number of bond and money market funds decreased due to mergers and liquidations. That's the lowest number of new stock funds since 1995, but the fact that it rose at all seems odd given the trends in that category. With the S&P 500 down 10% over the past three years, fund investors' once-rabid appetite for stock funds has slackened, according to Baseline/Thomson Financial.

Stock funds netted just $32 billion last year after redemptions, compared with the record $309 billion they gobbled up in 2000. While the number of bond and money market funds has essentially flat-lined over the past five years, the number of stock funds has nearly doubled. The average stock fund begins to cover its costs when it has about $100 million in its coffers, according to an industry rule of thumb. Of some 3,200 U.S. stock funds out there, more than four in 10 have less than half that amount, according to Chicago research house Morningstar.

It's not a leap to think that many of these funds won't exist five years from now, either due to their small size or increased consolidation. Overall, mergers were down last year, but 68 still happened in the brokerage and asset management industries, according to Mergerstat.com.

Last year, we saw 365 fund mergers, with about half triggered by merging fund companies streaming their combined product lines. When two fund companies wed, for instance, they might combine the assets of two large-cap growth funds, leaving the better-performing team in place and dismissing the other one. The larger surviving fund will generate more money in fees.

While this type of instability might rattle some fund investors, a broader view is calming. After all, higher competition for their dollars and fewer jobs for portfolio managers might make the fund business less cushy, but it puts fund investors in the sweet spot of a Darwinian trend.

The bottom line, folks, is that fewer funds means better funds.