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A merger of convenience

July 27, 2004 12:07 IST

Lately the mutual fund industry has been witness to a string of mergers between fund houses as well as consolidation of schemes within the same fund house.

Is this a merger of convenience necessarily a good thing for the retail investor? How should investors react to this consolidation? These are some of the questions we have tried to answer over here.

Last few weeks saw two significant mergers/consolidation within the domestic mutual fund industry. One involved consolidation within schemes of the same fund house -- Franklin Templeton Mutual Fund and the other involved merger of schemes between two distinct fund houses -- Principal Mutual Fund and SUN F&C Mutual Fund. Let us start with the merger between Franklin Templeton schemes, the more contentious of the two mergers.

At least one Personalfn client came out strongly against the merger of Franklin Templeton's FT India Asset Allocation Fund with the FT Life Stages Fund of Funds.

The reasons for the strong reaction were evident. FT India Asset Allocation Fund is a regular mutual fund that invests in stocks and bonds. It has been merged with FT Life Stages Fund of Funds, which as the name indicates is a fund of funds (FoF). An FoF is quite different from a regular mutual fund, especially where costs are concerned. For instance, the May 2004 fact sheet of Franklin Templeton indicates that the FT India Asset Allocation Fund had an expense ratio of 2.25%.

While a study conducted by Personalfn shows that the FT Life Stages Fund of Funds had a far higher expense ratio of 2.71%. This is nearly 50 basis points higher than FT India Asset Allocation's expense ratio. So a FT India Asset Allocation investor who had opted for the merger fund would have migrated from a lower cost mutual fund to a higher cost FoF.

From the investor's perspective, it is alarming that he has not been made aware of the higher costs involved in this merger. He has not even been informed of the benefits and advantages of this merger!

Of course, one point that Franklin Templeton's communication highlights is that with the merger there would be lower overlap between Franklin Templeton's schemes after its acquisition of Pioneer ITI. But that still does not answer the question on how the merger of the schemes would benefit the investor.

Another point that seemed to have rubbed a lot of investors the wrong way is the capital gains implications of the merger. The mutual fund treated the merger as redemption of old units and fresh purchase of new units. This implies that the investor would have incurred capital gains regardless of whether he opts for the merger or not.

Now lets tackle the other merger between SUN F&C Mutual Fund and Principal Mutual Fund schemes. This one made a lot sense to SUN F&C investors. Principal Mutual Fund is one of the more process-driven fund houses in the country today and tries to strike a balance between risk and return in its investment approach. SUN F&C was always more fund manager driven and its performance was nothing to write home about.

So investors from SUN F&C Mutual Fund will have come into a better-managed fund house with superior systems and a solid investment approach.

From the perspective of Principal Mutual Fund investors, the merger is a positive because the fund house now has scale, an important trait in the mutual fund business. Principal Mutual Fund for a long time struggled with a miniscule asset base of less than Rs 20 billion and the mergers with SUN F&C and PNB Mutual Fund would allow its investors to benefit from a larger asset base of over Rs 40 billion.

Of course, even this merger had some investors complaining as one fund in particular -- Principal Balanced Fund, saw its NAV dip by more than Rs 5 from Rs 15 to Rs 10. This was mainly due to the fact that SUN F&C Balanced was the larger of the two balanced funds; so Principal Balanced Fund merged into the SUN F&C Balanced Fund. However, in our view this is a technicality and given Principal's investment approach the consolidation should not affect investors adversely.

Mergers/consolidations are a way of life with most industries and the domestic mutual fund industry is no different. Every merger must be viewed in perspective. Some questions that you need to ask yourselves?

  1. Is the merged fund very different from the earlier fund in terms of risk-return?

  2. Is the merged fund a good fit in my investment profile?

  3. How are the costs of the merged fund going to be impacted post-merger?

  4. Is the new fund house that is going to be managing my money high on processes and systems? Does it have a balanced investment approach?

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