Small fund companies may face consolidation

The stock market downdraft may soon ignite consolidation among small mutual fund companies. Collectively, the nation's 477 fund companies that have less than $5 billion in stock and bond fund assets experienced $1.42 billion in net outflows in January, versus net outflows of $3.6 billion for all of last year, according to Financial Research Corp. of Boston. Meanwhile, assets in those firms totaled $318.8 billion at the end of January, down 5.5% from $337.2 billion in December, said FRC, which didn't include subadvised assets in its calculations.
Among the firms to see the biggest drop in assets over the one-month period were Oberweis Asset Management Inc. in Lisle, Ill., which saw its assets plunge 39% to $817 million. The bulk of the drop was in the $497 million Oberweis China Opportunities fund, which posted a 59.3% gain in 2007 but was down 22.3% year-to-date through Feb. 29. San Francisco-based Van Wagoner Capital Management experienced a 21.1% drop in assets to $29 million. A decrease in assets in Van Wagoner's three small-capitalization emerging-technology funds, due to underperformance, is largely responsible, said Garrett Van Wagoner, president of the San Francisco firm. "Stocks have never been cheaper," he said. "I think the sector will perform well later in 2008.'' Meanwhile, Jacob Asset Management of New York LLC in Redondo Beach, Calif., saw its assets fall 22.7% to $55 million, said FRC. Navellier & Associates Inc. in Reno, Nev., posted a 17.5% drop in assets to $184 million, according to FRC. "Investors get nervous as volatility increases," said Arjen Kuyper, president of Navellier. "That's the primary cause for redemptions." In January, the Standard & Poor's 500 stock index fell 6.1%. The Dow Jones Industrial Average, meanwhile, shed 4.6%, and the Nasdaq Composite Index dropped 9.9%.

ROUGH WATERS AHEAD?

Consolidation is not widespread yet, said Geoff Bobroff, a fund consultant in East Greenwich, R.I. "The volatility has not gone on long enough," he said. "If we stay in this funk for a longer period, like another six months, you might see some consolidation." Unlike such mutual fund giants as Boston-based Fidelity Investments and The Vanguard Group Inc. in Malvern, Pa., small fund companies are less equipped to weather big asset drops. As a result, they are usually the first to run to the deal table, or even to close up shop, when the going gets tough. Without a doubt, merger and acquisition activity among small fund companies has picked up since the second half of 2007, said Joe Machi, vice president and director of alliances at Federated Investors Inc. of Pittsburgh, which recently filed with the Securities and Exchange Commission to purchase the $40 million CB Core Equity Fund from Central Bank of Lexington, Ky., for an undisclosed sum. The deal is expected to close May 9. "There has been an increase in people taking actions on what in the past were hypothetical discussions," Mr. Machi said. "Almost everyone you talk to is at least thinking about it: 'Do I stay in? Am I an acquirer or a liquidator?'" said Bob Morrison Jr., president and chief investment officer at AFBA 5Star Funds Inc. of Alexandria, Va. The company's mutual funds experienced an 8.4% drop in assets in January to $250 million. Net outflows, meanwhile, totaled $1 million. Redemptions accelerated in the second half of 2007, Mr. Morrison said. "Our small-cap fund is where all the redemption activity has been" he said. "That fund had $250 million in the first quarter of 2007, and now it's down to $60 million." Organic growth has been a challenge for small firms, Mr. Morrison said. "We're looking for firms who are saying, 'we'd like to be able to get out of the business altogether,'" he said. "We haven't done any deals yet, but we have talked to a few firms already." "What I'm seeing is people who want to be acquired but they still want to manage the money," said Neil Hennessy, president and chief executive of The Hennessy Funds of Novato, Calif. "That's not in my game plan; we do asset purchase agreements." Since 2000, Hennessy has ac-quired four companies and nine mutual funds. The company had $1.2 billion in assets on Feb. 29, down from $1.7 billion at the end of 2007, thanks to a combination of depreciation and redemptions, Mr. Hennessy said.

FUND ADOPTIONS

In addition to outright acquisitions, some fund companies are looking to reduce costs by putting funds up for adoption. The adopting company usually assumes the fund's investment record, while the fund is usually renamed and sold as part of the adopting company's lineup. At the end of last year, Vanguard adopted the Laudus Rosenberg U.S. Large/Mid Cap Long/Short Equity Fund from San Francisco-based Schwab Corp. Vanguard reorganized its $11 million in assets into the Vanguard Market Neutral Fund. AXA Rosenberg Investment Management LLC of Orinda, Calif., continues to act as the fund's subadviser. Recently, Affiliated Managers Group Inc. of Prides Crossing, Mass., adopted the Skyline Special Equities Fund, which has $389 million in assets. The fund became part of AMG's lineup; Skyline Asset Management LP of Chicago continues to manage the fund. Others, meanwhile, are resorting to launching funds. At 5Star, the board has approved a new money market fund, which is expected to be launched within a month, Mr. Morrison said. "It's more of a defensive move," he said. "If investors are going to redeem out and go to [a] money fund, we'd like them to keep their money here." E-mail Sue Asci at sasci@investmentnews.com.