Over the past couple of years, the mutual fund industry has had more than its share of mergers and consolidation. It began a couple of years ago with Franklin Templeton taking over the Chennai-based Pioneer ITI.

As if on cue, HDFC Mutual Fund made a move for Zurich India Mutual Fund. After that there was a lull in the industry for some time. The silence has now been shattered by a renewed spate of mergers. At the end of the day, what do mergers bring to the table as far as the investor is concerned?

First the facts. Three significant mergers/consolidation happened over the last couple of months in the mutual fund industry. One involved consolidation within schemes of the same fund house -- Franklin Templeton Mutual Fund and the other two involved merger of schemes between fund houses -- Principal Mutual Fund and SUN F&C Mutual Fund being one of them and UTI Mutual Fund and IL&FS Mutual Fund being the other.

The consolidation of schemes within Franklin Templeton raised the hackles with some investors. To begin with, there was one merger too many. And more importantly in some instances the mergers did not really have any synergy.

For instance, it is difficult to understand the rationale behind the merger of Franklin Templeton's FT India Asset Allocation Fund (a balanced/hybrid fund) with the FT Life Stages Fund of Funds.

In an exclusive interview Personalfn asked Ravi Mehrotra, president, Franklin Templeton Mutual Fund, about whether the consolidation was expected to benefit the investors. Mehrotra said, 'We believe that such mergers are in the long-term interest of investors as they result in better economies of scale, and given that the total expense ratio limits are linked to the asset size, the mergers help in reducing the expense ratio.'

Rajat Jain (chief investment officer, Principal Mutual Fund) echoes the sentiment, 'It makes sense if your money goes to a better performing fund. The service standards are likely to improve as also the performance.'

To continue with the above example, the FT India Asset Allocation Fund is a regular mutual fund that invests in stocks and bonds. It has been merged with FT Life Stages Fund of Funds, which as the name indicates is a fund of funds. An FoF is quite different from a regular mutual fund, especially where costs are concerned.

For instance, the May 2004 fact sheet of Franklin Templeton indicates that the FT India Asset Allocation Fund had an expense ratio of 2.25 per cent. While a study conducted by Personalfn shows that the FT Life Stages Fund of Funds had a far higher expense ratio of 2.71 per cent.

This is nearly 50 basis points higher than FT India Asset Allocation's expense ratio. So a FT India Asset Allocation investor who had opted for the merger fund would have migrated from a lower cost mutual fund to a higher cost FoF.

To our question on the apparent mix and match between regular funds and FoFs, Mehrotra clarified, 'We are looking to eliminate duplication and our fund mergers take place wherever the schemes are similar in nature. Hence, if the migration is into a Fund of Funds scheme, which is more or less similar in construct as that of merging scheme, the investor gets to benefit from the additional advantages that a FOF offers.'

One point that seemed to have rubbed a lot of investors the wrong way is the capital gains implications of the merger. The mutual fund treated the merger as redemption of old units and fresh purchase of new units.

This implies that the investor would have incurred capital gains regardless of whether he opts for the merger or not. Mehrotra defends this move, 'From a fund house perspective, the alternative to a merger would be closing down the fund, in which case the tax implications would remain the same. In the case of a merger, the investor has an option to either continue the investment or exit at no load.'

The other mergers were less contentious in nature. At least the one between SUN F&C Mutual Fund and Principal Mutual Fund schemes seemed to have benefited investors from both fund houses.

It made a lot sense to SUN F&C investors mainly because Principal Mutual Fund is one of the more process-driven fund houses in the country today and tries to strike a balance between risk and return in its investment approach.

SUN F&C was always more fund manager driven and its performance was nothing to write home about. So investors from SUN F&C Mutual Fund will have come into a better-managed fund house with superior systems and a solid investment approach.

From the perspective of Principal Mutual Fund investors, the merger is a positive because the fund house now has scale, an important trait in the mutual fund business. Principal Mutual Fund for a long time struggled with a miniscule asset base of less than Rs 2,000 crore (Rs 20 billion) and the mergers with SUN F&C and PNB Mutual Fund would allow its investors to benefit from a larger asset base of over Rs 4,000 crore (Rs 40 billion).

Of course, even this merger had some investors complaining as one fund in particular -- Principal Balanced Fund, saw its NAV dip by more than Rs 5 from Rs 15 to Rs 10. Jain elaborates, 'The NAV went down because Principal Balanced merged with SUN F&C Balanced and investors got the NAV of SUN F&C Balanced Fund. Since the NAV of the latter was lower than Principal Balanced Fund's NAV, investors saw a decline in the NAV, but they also got more units. Holding 3 units at Rs 20 is the same as holding 4 units at Rs 15.

The IL&FS Mutual Fund merger with UTI Mutual Fund is one that would stand to benefit investors from the former more than the latter. This is because IL&FS Mutual Fund investors can now reap the benefit of UTI Mutual Fund's larger economies of scale, which generally tends to bring down the cost of fund management and adds to the returns generated by the fund.

From UTI Mutual Fund's perspective the merger has added to the assets under management further widening the gap between it and its private sector competitors. Apart from that, it is not clear how UTI Mutual Fund investors have benefited from this merger. So investors in UTI Mutual Fund can expect some mergers going forward given the overlap in UTI and IL&FS schemes.

One question a lot of investors are asking is whether the fund houses have been given a relatively free hand by SEBI in announcing mergers. Both Mr. Mehrotra and Mr. Jain disagree with this contention. Mr. Jain asserts, 'I don't think the regulations are loaded in favour of or against the fund house. Investors can exit from the scheme without an exit load if they decide not to opt for the merger.'

Some basic questions investors need to ask while reviewing the merger:

• Is the merged fund very different from the earlier fund in terms of risk-return?
  

• Is the merged fund a good fit in my investment profile?
  

• How are the costs of the merged fund going to be impacted post-merger?
  

• Is the new fund house that is going to be managing my money high on processes and systems? Does it have a balanced investment approach?

Mergers/consolidations are something that investors across sectors must learn to live with. From the mutual fund industry's perspective, every merger must be viewed objectively and investors need to ask themselves -- what's in it for me?

Mehrotra advises investors, "In case of a merger, investors need to keep the investment objective/style of the new scheme and evaluate whether the same fits their financial goals and risk profile." Jain believes investors should review the performance of the new fund manager, transparency and service levels.

Mergers aren't necessarily a bad deal. However, as an investor who is impacted by it, you need to do your homework well to ensure that at the end of the day you come out smiling.

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