Like any business, times can get tough. Once a company has more money going out than in, it must decide whether or not to go out of business. Mutual funds are no different. As an investor in mutual funds, you are technically a shareholder in the company (as opposed to a shareholder in the companies the mutual fund invests in). This means that the decision to close up shop is voted on by the shareholders. You’ll get plenty of notification of such a closing through whatever method the company already uses to send you statements (most people do this by mail).
Assuming the vote is approved by the required majority, the mutual fund has three options on how to close up shop. (Note this would likely be included in the vote):
Option 1: Liquidate
I love that word: Liquidate. For a furniture salesmen it usually means a “sale”, but for everyone it always means “turn whatever assets we have into cash.” Since mutual funds are invested in other stocks or bonds, the manager would sell all their holdings. The proceeds of the sale are then distributed to the shareholders in the form of a check. Unless you are in a tax-safe account, there are tax implications to the liquidation. Keep your records (and set aside some of the cash) to take to your CPA come spring-time.
Option 2: Merger
I’ve said this multiple times, but it cannot be said enough, mutual funds are just small companies. Another mutual fund can merge with the dying one just like a company can. This happens fairly often within mutual fund companies (like Fidelity or Vanguard) when two mutual funds have the same investment philosophy. But when an entire company shuts down, your fund could merge could merge with a competing fund. The buying company will give you shares of the bigger fund in exchange for shares in the smaller fund. So if you own two shares of Fund B (value: $50/share) and it was bought and merged with Fund T ($100/share), the buying fund will give you one share of T for every two you have in B. Those invested in either fund will benefit because more investors creates new synergies, reducing the management fees. Again there is a likelihood of tax implications, keep your paperwork handy.
Option 3: Full Sale
Like the merger, administration of the fund at the current company will end. So if Evergreen (the overpriced mutual fund company of Wachovia) is going out of business (they are not), they might be able transfer the assets in the fund to a new company. This could happen if Evergreen has a unique fund that Fidelity wants to add to their investing options. This has the least likelihood of having tax implications because all that would change is the brand name of the fund (and perhaps management). But again, because deals are made in fine print, keep your records.
I don’t have statistics on which of the three options is most common. If I had to guess, I would say the merger is the most common. Most mutual find investors would re-invest liquidated assets. Most mutual funds don’t have a fund so unique that a competitor hasn’t already copied it, so options 1 and 3 would seem more rare to me. But you never know.
As I stated yesterday, those of us that invest in index funds don’t have nearly as much to worry about. The commoditization of index funds makes mergers very easy and painless. The risk of them going down is reduced as well. Either everyone wins and we all make money, or the market crashes and we all lose everything. If that happens we have more to worry about than a nest egg, like finding food. I’ll take my chances on the index funds though.
Below is a very old story (like 2000 old!) that talks about how options 1 an 2 work. It’s kind of wordy, but if you know a thing or two about mutual funds it’s a good read.
This post was originally published on 10/28/2008
 By The Weakonomist |
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Don’t forget distribution in kind. This is rare and usually applies to those with large balances (such as business accounts), but the mutual fund company can essentially transfer over to you a proportional share of the various assets in the fund. So you would get 5 shares of MSFT, 7 shares of INTC, 100,000 of the 3month t-bill, etc. Doesn’t happen often but when a BofA enhanced Money Fund was closed, anyone with more then $1 million received a distribution in kind of all the assets.