Mutual fund mergers have never been a favorite subject of the
Securities and Exchange Commission
. And with good reason. When it comes to mergers, it's hard to figure out whose interests come first -- the funds' or the shareholders'.
"Mergers historically have caused the
Division of Investment Management
staff some sleepless evenings," says Barry Barbash, a former director at the SEC who is now a partner at the law firm of
Shearman & Sterling
. "There's a desire not to want to let managers bury their mistakes,
but on the other hand, also a desire to come up with a result that's good for shareholders" of lagging funds.
Fund companies say mergers are a painless way to let shareholders of small, high-cost funds enjoy the economies of scale of larger, more cost-effective ones. They also allow fund companies to weed out products that, for whatever reason, don't work.
But mergers can hurt the performance of the surviving fund and stick their shareholders with higher costs. (See
When Funds Collide, Survivors Often Suffer.) They also can allow fund companies to bury the track records of their worst funds.
"There isn't any SEC regulation that says once the fund gets merged out of existence, its performance record should continue to be published," says
Georgia Tech Dupree College of Management
Assistant Professor Ajay Khorana, who recently co-authored a study on fund mergers. "It's like they're
. The fund families are pulling off a disappearing act. If you merge a fund, the performance is gone."
For this reason, fund trackers such as
say their historical return data contains a "survivorship bias." In other words, if the records of lagging funds disappear, the averages for remaining funds will look higher than they actually were.
SEC officials wouldn't discuss specifics of what it looks for in deciding whether to approve a fund merger. In general, the commission strives to "ensure the shareholders are provided with complete and fair information about the terms of the merger," says Barry Miller, associate director of investment management at the SEC.
But the SEC did provide a recent clue to its attitude when it stepped in to stop the proposed merger of
Capital Opportunities fund, which had a loss of 1.6% last year, with the
fund. That combination would have obliterated the record of the 45-year-old $530 million Capital Opportunities fund. Stein Roe wanted the surviving fund to be the two-month-old Growth Investor fund, a clone of the successful
Young Investor fund, which returned 17.7% last year.
A Stein Roe spokeswoman says the company wasn't trying to bury Capital Opportunities' record. Instead, it was "giving shareholders access to a proven and compatible investment strategy."
In theory, a mutual fund's board of directors will weigh the shareholders' interests in deciding whether to approve an acquisition. (Shareholders of acquiring funds usually don't get to vote.)
But boards can be composed of employees of the fund companies. Even independent directors can be former employees of the funds they are supposed to be watching over, though the industry has proposed to curb this practice.
"Keep in mind that the board of directors are basically the same people who are the investment advisers, and what is their incentive? Their incentive is to increase the size to get higher dollar-management fees," Khorana says. "And you don't get higher dollar-management fees if you've got poorly performing funds sitting around."
But Chris Wloszczyna, a spokesman for the
Investment Company Institute
, the mutual fund industry's trade group, says directors "have to take a myriad of factors into consideration, and not just performance."
"In fact, they may even say we are willing to accept a slight decline in performance if the other benefits outweigh that," he says.
But in this case, it's still unclear whether shareholders share in those "other benefits."