James M. Clash

A wave of consolidation is washing over the mutual fund business. So far this year funds totaling more than $125 billion in assets have changed hands. To hear the consolidators tell it, mergers are good because they bring fund investors economies of scale and breadth of choice within a fund family. Will these promises be fulfilled? It is instructive to consider some of the bigger recent mergers. The results are not encouraging.

Take the Dreyfus funds, purchased in December 1993 by Pittsburgh’s Mellon Bank. In the three years before the merger, the 12 domestic stock funds at Dreyfus performed, on average, on a par with the S&P 500 index. In the three years since, these funds, on average, have underperformed the index by a stunning seven percentage points a year.

Then there’s the American Capital/Van Kampen merger in August 1994. In the 26 months prior to the marriage, the 11 stock funds here outperformed the S&P 500 index by an average of two points annually. In the 26 months since the merger, the funds have underperformed, by two points annually. Do fund shareholders at least benefit from economies of scale? Not really. Average expenses at both the Dreyfus and American Capital families are just about where they were before they changed hands, notwithstanding that assets are up.

FundsEven the Templeton family seems to be suffering from postmerger letdown. These mostly international funds, founded by the revered investor john Templeton, are still market beaters, but they have seen a sharp falloff in how much they beat their benchmarks.

San Mateo, California–based Franklin Resources bought control of the Templeton Family for $786 million on Oct. 30, 1992. The move gave Franklin, then primarily a bond fund firm, an instant international equity presence— and reputation—that helped market the combined firm’s assets.

Templeton’s two star managers, Mark Mobius and Mark Holowesko, signed what were essentially four-year employment contracts and were given fat cash bonuses and salary increases. Sir John Templeton, already cutting back from daily operations, bowed out almost entirely when the acquisition was finalized.

Not long after the merger, trouble began. Templeton’s managers were not happy with the new bonus structure; suddenly their bonuses weren’t linked just to their equity performance but to Franklin bond mangers’ performances, too. Templeton Chief Executive Thomas Hansberger quit in 1993 to found a rival institutional firm, Hansberger’s Global Investors, and took a bunch of Templeton staffers with him. Recently there has been further attrition as employment contracts begin to expire.

What has all this meant to Templeton’s shareholders? All four of Templeton’s big open-end international equity funds with at least four years on each side of the merger (a combined $27 billion in assets) show postmerger return declines against their respective benchmarks. (See Table 2.) The average drop in relative annual performance: a stunning six percentage points.

What about the hoped-for economies of scale? They didn’t happen. While average assets in these four Templeton funds have more than doubled, expenses have not gone down. They have increased by a third, from an average $0.84. per $100 of assets annually to an average of $1.12.

This is not to say that the Templeton funds are a disaster for investors. Even with the relative petering out of their returns, the four still beat their Morgan Stanley benchmarks for international funds. But the simple fact is that they are not the winners they once were.

Mark Holowesko, president of the global equity group at Templeton, explains the postmerger weakening of performance as a consequence of too small a dose of Japanese stocks. He says expenses are up because the funds are invested in more countries, some of them—like Russia and Poland—very expensive to research. Holowesko says he plans to stay. Templeton’s departure was not as traumatic as it may have seemed; the founder had already ceded most stock picking decisions in the late 1980s.

There has always been a question about whether fund buyouts are good for shareholders of the acquired firms. But this year, with a record half-dozen big fund acquisitions announced—including $50 billion-plus American Capital/Van Kampen by Morgan Stanley, and $57 billion AIM Management Group by INVESCO Funds Group Inc.—the stakes have risen Arguments for consolidation are simple. First, lower expenses should be realized through economies of scale from combining back-office operations. Second, increased purchasing clout with a larger asset pool should result in better access to Wall Street research. Finally, if the fund family being acquired is small, consolidation can free money managers from diversions like marketing so they can spend more time picking stocks.

Arguments against consolidation are less tangible, _James Margard, chief equity strategist at $3 billion Rainier Investment Management, a pension fund manager in Seattle, maintains that stock pickers are much sharper when they’re independent. “They got complacent once they cash out and buy the big sail boat,” sot Margard, who has been approached by several firms interested in gobbling up his 15-year-old company, which runs the excellent mutual fund Rainier Core Equity Portfolio. So far, he has resisted. “My investors are better off when I’m hungry,” he says.

There’s also the potential for disharmony when two corporations merge, and it can affect the performance of money managers, even causing some to quit. When Merrill Lynch bought $9 billion Hotchkis & Wiley this year, most of the bond department left.

What should you do if your fund company sells out? If the portfolio manager of a fund you are in stays put, it probably makes sense to give the new owners a chance. But keep a close eye on the situation. Franklin just paid some $610 million for Heines Securities, operator of the excellent Mutual Series fund run by Michael Price. Supposedly Price’s attention has been secured by a five-year contract and up to $193 million in performance incentives. But Price can go part-time after just one year, so his heart may not be in the job after that.

The other thing to watch for is the cost of ownership. If expenses climb, consider departing. The hitherto no- load Mutual Series funds have often been on the Forbes Best Buy list for U.S. equity funds. They will have a hard time staying there; effective Nov. 1, Franklin began charging a sales commission of up to 4.5%

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