Advisor Partners recently completed a research study that evaluated mutual fund performance in connection with a soon-to-be-published book, The Safe Investor: How to Make Your Money Grow in a Volatile Global Economy by Tim McCarthy (Palgrave Macmillan, February 2014). Among other things gleaned from its research, the Walnut Creek, Calif. investment advisor found that survivorship of mutual funds was strikingly low and that investors are likely to outlive many of their mutual funds.

The research measured mutual fund survivorship rates, identified patterns and leading indicators and provided constructive guidance about what to do with this information. For investments designed to be short-term in nature, the tendency of funds to close or merge isn’t a major consideration. But when investments are part of a long-term portfolio strategy, an ill-timed closure or merger may create unintended consequences.
An analysis indicated that funds can fail based on the following reasons:

• Size: Larger funds are more likely to stay in business. 
• Performance: Funds with good performance track records are more likely to survive.
• Star ratings: The star system is in many respects a stronger proxy measure for survivorship than it is for identifying future top-performing funds.
• Parent company stability: The fund’s parent company is an important, but harder to evaluate, factor in survivorship. 

When a fund is merged out of existence, the “surviving” fund is often different from the fund originally purchased. In many cases, additional costs are absorbed by the fund in connection with the merger or closure. When a fund is liquidated, transaction costs associated with the liquidation can reduce the returns of the funds. Although these costs at the individual shareholder level can be relatively small, any drag on returns in a low return environment can be meaningful.
The transition process often creates hidden costs or inefficiencies for investors, as portfolio managers reposition the fund for closure by raising cash. In the case of a merger, the portfolio managers often reposition the fund pre-merger to look more like the fund it is merging with, which can create a subtle but meaningful change in the risk and performance profile.

In most cases, there is no reason to stick around if a fund is being closed. The fund will incur transaction costs during the liquidation process and in many cases will be managed by distracted portfolio managers who are serving as caretakers under the supervision of a team of lawyers. We’ve observed several examples over the years of funds drifting from their mandate during a wind-down process. Better to leave the fund than risk an unexpected outcome. One caveat is the tax consideration––if the investor wants to minimize gain realization, it may make sense to delay redemption if doing so converts a short-term gain to long-term status or defers the gain to the next year.

In the event of a fund merger, the decision-making process is different. The key decision involves evaluating whether the merged fund fits your client’s portfolio and whether it is of a quality that you are looking for.

But the bottom line is that advisors need to pay attention when funds are merging or closing. It can make a significant difference for clients.

Dan Kern is the president and chief investment officer of Advisor Partners. Tim McCarthy is the former chairman and CEO of Nikko Asset Management Co. and former president and COO of the Charles Schwab Corporation. The complete research study is available at