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Performance Overview
Continuing a trend that started in March, funds delivered strong gains in the third quarter on the back of surging equity and bond markets. Once again, higher risk areas outperformed as funds with significant exposure to high-yield bonds, small-cap or emerging-markets equities, or to the financials or resources sectors derived benefit from rebounds in those areas. On the flip side, funds that continued to emphasise government bonds or defensives such as large-cap pharmaceuticals or consumer staples lagged.
Despite that strength, we think investors and fund houses should exercise caution. Some houses have already suggested they might try to launch more higher-risk vehicles to take advantage of recent performance trends. In our view, this is the wrong path to take: funds are meant to be long-term investments and to serve investors well in that regard, they should not be launched just to capture whatever the market happens to favour at a point in time. For investors, we think the best course of action is to design a diversified portfolio in line with their long-term risk tolerance and investment goals, ignore short-term noise, and to rebalance as needed. Our own research suggests most investors cost themselves performance (not to mention sales charges) by trying to time moves in and out of different slices of the market.
Industry TrendsDuring the boom years that came to an abrupt end in late 2007, the European fund industry rapidly expanded in an attempt to gather assets. The result was far too many funds chasing a pool of assets that was too small to permit many offerings to achieve economies of scale. Morningstar currently tracks a universe of 33,105 European domiciled funds excluding money-market offerings (36,779 with money-market funds). This compares to only 6,736 non money-market funds domiciled in the United States. That's not an unreasonable comparison: While Europe's population is more than double that of America, the size of assets invested in funds is in the same general neighbourhood, with EUR 4.5 trillion in funds compared to EUR 3.8 trillion in the US, ex MM and ex FoF. ( Europe asset figure consists of UCITS offerings ex Money Markets and ex funds-of-funds, plus non-UCITS funds at 30 June 2009; data from Morningstar and EFAMA).
Outside of money-market funds, the current largest funds in Europe top out at EUR 14.5bn, with roughly 100 offerings-- only 0.03% of the non money-market universe by number of funds-- at more than EUR 1bn. In the United States, the largest non money-market funds top out at EUR 127bn and there are 862 funds (12.8% of the universe) with more than EUR 1bn in assets.
In our view, this proliferation of funds in Europe has had poor results for investors. While investors have increased choice, funds are unable to achieve economies of scale and must spend a great deal on distribution to compete in a crowded market. Although other factors are certainly at work-- poor governance structures and inadequate regulatory frameworks chief among them-- a significant knock-on effect of this over expansion is that funds in Europe are costly to own, which erodes investors' returns through time.
We therefore believe investors would benefit from a consolidation and rationalisation of fund line-ups. We have seen a clear trend in that regard in the past few years, but none as strong as in 2009, when for the first time since the credit crunch began, Morningstar projects that more funds will be closed in Europe than launched. In all, 2,968 individual funds (the figure excludes multiple classes of the same fund) have closed for the year to date, with 996 of those merged and 1,972 liquidated. Assuming the same level of activity, this equates to projected fund closures of 3,957 for the year. That would be a 22% increase in closures from 2008 and a 73% increase in closure over 2007. At the same time, only 1,560 new funds have launched in Europe for the year to date, which projects to an estimated 2,080 for the full calendar year--down 45% from 2008 and 43% from 2007. If trends hold, this suggests the European domiciled universe of funds will shrink by 1,877 funds or 5% of its size at the start of the year.
Although we think the larger trend is for the best, investors and advisers should keep in mind that fund houses are undertaking this activity to ensure their own profitability, not to help fund owners. Specific dangers to investors include being put into a fund that is not invested in a similar style or asset class or one that has a lesser manager, or if a fund is being liquidated, having one's assets increasingly in cash. In the event their fund is merged, we believe that investors should take the opportunity to fully assess the available universe of options rather than to accept where the fund company places the assets. One may well find superior management or a fund that better fits into the investor's portfolio plan by moving away from the previous fund house, although switching costs must always be kept in mind.
| Year | Net Change in No. of Funds | Count Launched | Count Closed | Count Merged | Count Liquidated |
|---|---|---|---|---|---|
| Projected for all of 2009 | -1877 | 2080 | 3957 | 1328 |
2629 |
| First Three Quarters of 2009 | -1408 | 1560 | 2968 | 996 |
1972 |
| 2008 | 554 | 3787 | 3233 | 1079 |
2154 |
| 2007 | 1401 | 3685 | 2284 | 632 |
1652 |
Source: Morningstar, Inc. Counts include all funds domiciled in Europe. Projections made on straight-line basis.
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