getTagNameMorningstarCorporate:blog/bigpicture
Fund Closures: The Cause and Effect
How fund closure can impact an investment strategy
In Morningstar Inc.’s latest research, we wanted to
better understand fund closures and their impact on investment
strategy. Our study sought to explain factors leading to fund liquidations
and mergers, so that we can recognize funds that should be closed down
but are currently still alive. In doing so, we can help investors
filter out the bottom portion of the investable universe for
individuals looking for long-term vehicles as part of their investment strategy. The main conclusion of our paper is simple: Funds become obsolete
because they do not generate enough value for their investors and do
not have enough assets to sustain the operational costs of running the
fund. Investors should be wary of such funds currently exhibiting
characteristics such as underperformance, low fees, and high outflows.
On the other hand, popularity—at the firm and category level—plays an
outsized role in dictating fund survival. Funds from unpopular
categories and funds from firms who have high historical rates of
closure are at higher risk of becoming obsolete. In the U.S., high-fee funds have been less likely to close than
lower-fee funds. That’s with all else being equal. At a first glance,
this idea seems wrong. But let's think about who’s actually in charge
of the process of closing down funds: the firm. Shutting a fund down
can be time-consuming, painful, and costly. So if a fund is
unsuccessful, investors can vote with their feet and exit a fund on
their own. Yet, if a high-fee fund still has enough assets under
management to maintain profitability, why would the firm willingly
sustain the cost of shutting down a fund? A high-fee fund is more
likely to generate income for the firm than a low-fee fund, especially
after holding growth rates and assets constant. Therefore, the lower
risk of closure for a more-expensive fund makes sense. The firm may
not market it, sell it, or put much effort into maintaining the
investment, but they will be less prone to shut it down. As a result,
more high-fee funds are kept open, after all else is considered. The outcome of this study coalesces around one central point: The
fear of closure may be misplaced. For many investors, fund closure
itself is not the problem. It is events preceding closure—the
outflows, the liquidations, the underperformance—that tend to harm
investors. Furthermore, this paper is evidence that fund closures are
often forecastable. Funds tend to leave a trail of signals that
closure is inevitable. These signals start tend to start appearing six
months to two years out, perhaps even longer. The headache an investor may face is not closure itself, but
deciding whether to act on the information that a fund closure is
pending. Acting means they must consider replacing the fund. Not
acting means they ride out the looming fund liquidation. Either option
has unavoidable consequences. Mergers will likely alter the
portfolio's investment allocation. Replacing the funds will likely
result in due-diligence costs. Liquidations may cause a hefty tax bill
and a period of sustained underperformance. At Morningstar Inc., we have the data to help investors identify
potential fund closures. By turning such findings into analytics, we
can help investors monitor their portfolio to better understand when a
holding becomes at risk, so they can make an educated decision for
investing in the long term.Madison Sargis
What causes fund closure?
How do funds avoid closure?
What’s the impact of fund closures on investors’ investment strategies?
How is Morningstar working to help investors?
Read the full research paper “The Fall of Funds:
Why Some Funds Fail.”