Who does your mutual-fund manager work for?
The question usually doesn’t come up as a top criterion in picking funds. But there is an increasing chance the company that signs your fund manager’s paycheck is likely to change one of these days, and that can raise caution flags for fund investors.
The sale of a fund company can trigger a chain reaction affecting the choice of managers or the fund’s investing style, creating uncertainty and perhaps affecting investment returns for shareholders. For small fund firms in particular, “It’s not a very good thing for shareholders when the company is sold,” says John Rekenthaler, director of research at fund tracker Morningstar Inc., Chicago.
Such concerns are facing more shareholders this year as mutual-fund firms go on a new-millennium merger kick. More than 220 mutual funds with about $50 billion in assets are affected by this year’s changes in ownership announced so far, industry experts say.
“There are more large deals this year by a factor of two or three,” says Gregory J. Fleming, head of the U.S. financial-institutions banking group at Merrill Lynch & Co. “This is a business any financial company is trying to grow. Around the world, most places are trying to build asset management.”
Already, a handful of billion-dollar deals have been unveiled, including Pioneer Group Inc.’s announced sale to Italian bank UniCredito Italiano Group, Sanford C. Bernstein & Co.’s agreement to be bought by Alliance Capital Management Holding LP, French financial-services firm Caisse des Depots Group’s proposed purchase of Nvest LP, Nationwide Mutual Insurance Co.’s acquisition of Gartmore Investment Management PLC, Old Mutual PLC’s proposed buyout of United Asset Management Corp. and Bank of America Corp.’s pending purchase of the Marsico Capital Management LLC stake it didn’t already own.
For the year through late August, 44 investment-management firms, many of which run mutual funds, have agreed to acquisitions or mergers in deals valued at $9 billion, according to SNL Securities, a Charlottesville, Va., financial-research company. The number of deals so far in 2000 falls just shy of last year’s 12-month total, and the value of those deals is on pace to set a record.
There is no end in sight. After a late-summer lull, several more deals are being considered involving both U.S. and European firms, investment bankers say. “As long as firms keep getting founded and founders keep getting older, this won’t be over soon,” says Donald Putnam, managing director of Putnam Lovell Securities Inc., a San Francisco investment bank that focuses on asset-management firms.
The main driver behind the acquisition binge is the presence of European insurers and banks willing to spend healthy premiums to gain the expertise of U.S. investment firms. Such money-management skills are in high demand as countries across the world adopt the U.S. model of defined-contribution retirement plans that usually are built around mutual funds.
U.S. investment managers, meanwhile, are cashing in on the boom growth years of the 1990s. Recently, they have liked the prices their firms are fetching and view deep-pocketed international buyers as good global-distribution partners. Based partially on the takeover mania, asset-management stocks have risen about 80 percent this year.
Fund companies say takeovers can be good for fund shareholders as well. Fund firms usually reassure investors in their proxy statements that the new owners will have no impact on the way the mutual funds are managed. Independent fund directors, who vote on all fund company mergers, also are supposed to make sure that shareholders don’t get hurt in the acquisitions.
But whatever the benefits, there also can be disruptions affecting fund investors, some of which may not appear until after the first six to 12 months following a takeover. Unless they have contracts committing them to stay, individual money managers can become disenchanted with the new owners and decide to leave. Even a manager who decides to stay after selling an ownership stake may be signaling a desire “to notch his or her career down,” Morningstar’s Rekenthaler says.
The new owners also may have different plans for a particular fund and change the manager or the investing style of particular funds. Costs of investing sometimes go up, and a new flood of assets that may come with a new owner make it more difficult for a fund manager to invest nimbly.
“It’s a red flag for us” when a fund manager is sold, says Ronald Roge, a financial adviser in Bohemia, N.Y
To be sure, fund investors shouldn’t be hasty in selling their shares upon hearing of a deal. Sometimes “it’s an event of no significance to shareholders,” says Milton Stern, a financial adviser in New York. In 1997, an investment firm overseeing some of his clients’ money, Tweedy Browne Co., sold a majority stake to a larger fund firm, Affiliated Managers Group Inc. Stern kept doing business with the fund and says he has noticed no deterioration of performance.
Indeed, fund buyouts also can help shareholders, according to Stern and other advisers. Some poorly performing funds are merged out of existence, and other funds benefit from the investment research resources of a larger investment management firm.
Even a manager departure after a merger isn’t necessarily a straight sell signal. For example, about a year after Mellon Financial Corp.’s 1998 purchase of Founders Asset Management, the lead manager of Founders Passport Fund left. Stern pulled about half his clients’ money out of the international fund, in response. But the new manager actually improved performance.
Still, fund company mergers should put shareholders on alert. Perhaps the most important, and difficult, factor to gauge is how the deal structure will affect the manager’s motivation. After a deal, the fear is that “the manager leaves or doesn’t have their soul in it anymore,” says Wade Dokken, president and chief executive of American Skandia Inc., a variable-annuity firm in Shelton, Conn.
Roge, the adviser, has been cautious on manager combinations since a small fund boutique with which he had invested $6 million formed an alliance with Strong Capital Management in 1996. The fund, Strong Schafer Value Fund, has underperformed since the alliance, and Roge has pulled his money out. The fund manager “had wonderful results when it was just Schafer Value,” he said. David Schafer, the manager, replies that the fund beat its peer group in 1996 and 1997, adding that “the alliance had nothing to do with our underperformance.” Instead, he blames the cold streak on the sluggish returns of undervalued low-priced stocks during the past three years.
For astute investors, a slip in performance may not be as alarming as a shift in a fund’s strategy or management style. Last year, Ric Edelman, a financial planner in Fairfax, Va., took his clients’ money out of Northstar Income & Growth Fund, a balanced fund using both stocks and bonds, after the fund company’s parent merged Northstar’s fund operations with Pilgrim Capital Corp. Within a few months of the deal announcement, one of the managers of the Northstar fund had left, the name of the fund was changed, and the assets were transferred into a Pilgrim fund with a different management team.
Another issue to watch out for, according to Morningstar’s Rekenthaler, is whether fees go up after a merger. While this doesn’t usually happen to existing shareholders, mergers eventually can lead to new shareholders having to go through intermediaries with higher fees to invest in a fund.
Ralph Wanger, head of his Chicago asset-management firm and lead manager of its flagship Acorn Fund, says his shareholders also should be happy about his company’s pending sale because it plots a succession path. (Wanger and nine other employees at the firm have pledged to stay on board for at least five years.)
“We can now recruit young people that know they’ll be in a business that will survive,” Wanger said. “I’m now 66, and it doesn’t take a lot of serious analysis to realize I’m going to have to reduce my activity at some point.”
