With the savage stock markets of the past year taking a nasty bite out of asset values in many mutual funds, several fund companies have decided to axe funds that are too small to pay their way or that are simply redundant in an overcrowded market.

And many fund companies are questioning the wisdom of launching more sector funds, as their narrow industry or geographical niches tend to limit investment options and create extra volatility.

Industry giants such as CI In-vest-ments Inc., Invesco Trimark Ltd., AGF Funds Inc. and TD Asset Management Inc., all based in Toronto, have taken a hard look at their fund lineups and have decided to slim down — shuttering funds or merging them into existing funds.

“The industry has been through a severe market downturn, and it’s still playing out,” says Rudy Luukko, investment funds editor at Morningstar Canada in Toronto. “The logical course of action when demand is reduced is to reduce supply. When the industry was in high-growth mode, it became overbuilt, and some funds are no longer economically viable. There’s been some weeding out, and there are quite a few weeds out there.”

Many of the disappearing funds were launched to take advantage of hot trends such as the income trust craze. Now that the fever has cooled, these funds’ assets under management have shrivelled, with little hope of a comeback.

“If a company launches a hot fund when a particular market sector is hot, it gets a lot of traction,” says fund analyst Dan Hallett, president of Windsor, Ont.-based Dan Hallett and Associates Inc. “But when the heat dies down, the fund is hit by a double whammy of shrinking investment values and rising redemptions.”

In other cases, fund companies have made acquisitions that have resulted in duplication in their product lines. With growing compliance costs and soaring operating expenses, it makes sense in such cases to merge funds to take advantage of economies of scale. Ultimately, the disappearances will result in fewer funds with narrow mandates, and more efficient cost structures for clients who have been moved to bigger, broader and more enduring funds.

AGF recently terminated its AGF World Opportunities Fund because of insufficient AUM, and has also merged some sector funds in health sciences, technology and financial services. Its 20-year-old AGF Special U.S. Class Fund, along with lagging performer AGF U.S. Value Class Fund, have been merged into the broader AGF American Growth Class Fund. On the income side, AGF Diversified Dividend Income Fund has been blended with AGF Monthly High Income Fund.

“Funds with a narrow focus are being merged into funds that will provide broader diversification,” says Rob Badun, AGF’s executive vice president, investments. “AGF is still providing exposure to a particular sector but within a broader-based equity product [that] provides investors with diversification across a multitude of sectors. Advisors have been telling us that inves-tors are more interested in a back-to-basics approach that focuses on core products that are more broadly diversified. These mergers will simplify and streamline our product lineup for unitholders.”

Invesco Trimark is merging six mutual funds into others within its fund family. Among the mergers, Trimark Global Technology Class Fund, Trimark Global Technology Fund and Trimark Discovery Fund will all be merged into the broader Trimark U.S. Companies Class Fund by the end of July.

Using Trimark Global Technology Class Fund as an example, clients will see a lower management expense ratio of 2.77%, vs 2.93% on the original fund. There will be continuity of management, as Invesco Trimark vice president Jim Young manages both funds, although the continuing fund has a much broader mandate. Trimark U.S. Companies Class Fund offers exposure to technology, with 23% of its AUM currently residing in that sector. It also has the flexibility to invest across all sectors and is expected to provide lower volatility.

Among recent mergers, National Bank Securities Inc. is folding 29 of its funds into others, with many of the mergers resulting from duplication that arose after the purchase of Altamira Investment Services Inc. in 2002. The Altamira brand remains in the family, along with National Bank funds, Omega funds and Meritage fund-of-funds portfolios. As part of a mandate change, Altamira U.S. Larger Company Fund is now called Altamira U.S. Equity Fund and can invest across all market capitalizations.

@page_break@“However you slice it, 29 funds have disappeared, and they’re all now in one big fund family,” says Luukko. “National Bank has reduced the overlap between product lines, [and] it’s a lot cheaper to run a single family.”

CI is also purging its lineup, proposing to merge 16 funds by mid-August to eliminate some niche funds and smaller brand names it has acquired. Five of the funds to be merged are branded with the Knight Bain label and were previously offered by Rockwater Capital Corp. of Toronto, acquired by CI in 2007. They will be merged with funds offered through CI’s Signature Global Advisors division. Some of the funds being merged have narrow mandates such as consumer products and biotechnology. Income and corporate bond funds are also being merged into funds with more diversified income mandates.

“CI has made eight acquisitions over the years. Some duplication of funds has happened as we’ve become a larger organization,” says Derek Green, president of CI Investments, CI Financial Corp.’s fund arm. “Our objective is to have big, broadly mandated funds.”

Green says four of the 16 funds are niche funds launched more than a decade ago, and three have less than $75 million in AUM. Nowadays, when CI launches a new fund, it is targeting at least $500 million in AUM within two years.

“When we launch a product, we ask ourselves: ‘What is the reputational risk?’ And that risk is much higher for a narrow niche or geographically specific product,” Green says. “We like to give our managers the more open mandate of a broadly diversified fund, so they have the latitude to manoeuvre and are not confined to a narrow sector.”

Green says it is also CI’s objective to be an industry leader in terms of reasonable management fees, and that leadership is difficult to achieve with small funds. Because CI commits itself to fixed rather than floating MERs, Green says, it is critical for funds to be big enough to absorb the costs of doing business. Otherwise, CI’s shareholders bear the pain of reaching into the company’s pockets to pay expense overruns.

“The costs of running small funds are much higher as a percentage of [AUM] and are often subsidized by the fund company,” Hallett says. “Merging small funds into a broader funds helps to keep fees level and avoid future increases.”

IA Clarington Investments Inc. of Toronto is also trimming its fund lineup, and at the same time it has culled its list of external fund managers by six firms. Eric Frape, IA’s senior vice president, says most of the funds being merged have AUM of less than $100 million and some have less than $25 million.

“There are redundancies in the lineup due to acquisitions,” Frape says. “We had seven balanced funds, for example, and are cutting back to four. We don’t want duplicate mandates, but we are trying to retain funds where the manager has a following or a distinct style or investment approach.”

He stresses that the intention isn’t to bring all funds under inhouse management, and says the firm will continue to keep external managers in the mix. Three of the purged managers manage funds for competing firms.

Some of the merged funds will be enjoying some significant decreases in fees. For example, IA Clarington Canadian Value, with an MER of 2.5%, is being merged into IA Clarington Dividend Growth, which has an MER of 2%. As well, IA Clarington Canadian Growth & Income (MER of 2.5%) is being merged into IA Clarington Monthly Income Balanced (MER of 1.85%).

In addition, the popularity of exchange-traded funds may be having a bearing on the mutual fund consolidations among sector and niche funds, Luukko says. Investors attracted to narrow niches are often active traders, and ETFs can be a more suitable vehicle for frequent trading. ETFs trade on stock exchanges and offer intraday liquidity. They also tend to have lower management fees than mutual funds.

By culling lineups of the narrowly focused funds, management firms are also getting rid of the funds that tend to be the most volatile. Extreme volatility tends to discourage investors from sticking with a fund for the long term and encourages the destructive pattern of buying high and selling low.

Even if these funds produce attractive long-term returns, clients often don’t have the staying power to stick around to reap those
returns.

IE