The fund consolidation trend: What your fund should be thinking about

June 23, 2021

By Jeff Haneline, Cohen & Company

According to Morningstar, over 1,000 mutual funds went through business combinations over the past three years. This was a consistent theme in 2020 and has continued into 2021, showing no signs of significant slowing even with the ongoing pandemic. Conversions from one structure to another have also been a common discussion topic among industry participants over the past few years.


There are plenty of reasons for the trend: sustained pressure around fee compression, distribution challenges, product rationalization, changing investor demographics, an industry shift to ESG as a primary focus, and increased investments in technology to remain competitive. It also doesn’t hurt that valuation multiples for both large and small deals remain high.


Regardless of the "why," the reality is that fund shops continue to search for alternatives in an attempt to gather assets and enhance the long-term viability of their product offering. Whether you are considering a conversion, actively looking to merge your fund with another industry player, or you become an unexpected deal target, consider the key areas below early on.


What Matters Most When Thinking About a Merger

For various reasons, no fund structure is immune to a potential business combination. Mutual funds continue to compete with lower-cost and primarily passively managed exchange-traded funds. Industry participants have been contemplating mutual fund-to-ETF conversions for several years, and Guinness Atkinson effectuated the first of its kind earlier this year. Dimensional Fund Advisors is next in line, and we anticipate seeing others follow suit now that the trail has been blazed. Separately managed accounts or private fund conversions into publicly offered funds have been another consistent topic of discussion over the past several years, as advisers try to broaden their reach to retail investors. Highly innovative and well performing ETF managers may look to a consolidation to achieve the necessary scale to distribute their funds more broadly. Closed-end interval funds continue to offer exposure to illiquid asset classes that were otherwise only offered to qualified or accredited investors in a private fund wrapper. The registration process for a publicly offered fund can be timely, so it is not unusual for advisers that have committed assets to commence operations as a private fund and later convert to a publicly offered fund once the registration process is complete. Whatever the reason, investment banking firm Piper Sandler predicts mergers will continue over the next decade, suggesting that the industry will have half as many advisers in 2030 as there were in 2020.


As investment company managers continue to navigate these headwinds, firms must remain conscious of the impact consolidations have on both advisers and shareholders. The 14 members of the Forbes Business Council recently contributed to a list of what they believe to be important factors to think about when considering a merger. It should not come as a surprise that focus on culture, customers, clarity, and communication were common themes within their responses. Know what is most important to you and your clients and, as one member noted, be willing to walk away if the deal isn’t right.


These things take time. Make sure you are communicating appropriately with your financial adviser networks well in advance of a merger, notably regarding the impact on client service, the plan for overlapping products and impact to expenses, to name a few.


Regulators In the Mix

The Securities and Exchange Commission has clearly taken notice of the business combination trend as well. The SEC adopted amendments to financial disclosures about acquired and disposed businesses for all issuers in 2020. Prior to this, there were no specific rules related to financial reporting for business combinations of investment companies.


Specifically, the Commission added new Rule 6-11 to Regulation S-X and amended Form N-14 to clarify the financial reporting requirements for business combinations of investment companies and business development companies. The last thing fund companies want are interruptions in the registration/filing process because of non-compliance with the new rules and amended forms. If you are thinking about or are in the process of effecting a business combination, be aware of the following items:


  • Updates to the significance tests for entities to be combined
  • Private fund to public fund considerations
  • Supplemental financial information requirements in lieu of pro forma financial information
  • Acquired fund and supplemental information need only be filed once


Advisers should be aware that the new rules and requirements are currently effective for business combinations that happened or will happen after Jan. 1, 2021. Having a conversation with your independent registered public accounting firm and legal counsel prior to submitting the necessary filings will certainly help avoid any delays in the process.


We’d be remiss not to highlight one of the more important considerations with any business combination: tax implications. Most fund mergers are accomplished tax free, whereby shareholders retain their original basis and are not taxed until future disposition of their shares (no different than if a fund never merged). Obtaining a tax opinion from your legal counsel is a vital step in the process to help ensure your shareholders are not taxed as a result of a business combination.


Whether you are aiming for a merger of two public funds, a private fund or SMA merging into a public fund or a mutual fund converting to an ETF, each can be accomplished tax free if certain requirements are met. Consulting with your tax professionals in the process will be imperative as well. The last thing you want is to fail the requisite Internal Revenue Code requirements and forfeit the benefits afforded to regulated investment companies and their shareholders under the tax code.


What Boards Need to Know Throughout the Process

As with anything in the regulated investment company industry, boards play a pivotal role in determining whether or not a business combination is in the best interests of the fund and will not dilute shareholder interests. Boards are expected to interact with advisers throughout the process and understand that replacing a portfolio manager or liquidating a fund may be reasonable alternatives to a merger. Extensive due diligence and oversight throughout the process is necessary in forming a conclusion. In fulfilling their fiduciary duties of care and loyalty, boards for affiliated fund mergers can reference SEC Release No. IC-25666; File No. S7-21-01, which suggests considering the following list of non-exhaustive and non-singularly determinative factors, amongst others as appropriate in the circumstances:


  • Any fees or expenses that the fund will directly or indirectly bear in connection with the merger;
  • Any effect of the merger on annual fund operating expenses and shareholder fees and services;
  • Any change in the fund's investment objectives, restrictions and policies that will result from the merger; and
  • Any direct or indirect federal income tax consequences of the merger to fund shareholders.

Unaffiliated fund mergers create additional challenges. Boards on both sides of the proposed business combination will need to expand their due diligence to include additional advisers, service providers, valuation and other policies, technological capabilities, etc. Consolidation is not unusual, so boards should consider which members are the most appropriate to remain as directors of the surviving fund and plan for transition accordingly.


Large or small, fund companies continue to consolidate funds in an attempt to streamline their offerings and provide the optimal product suite for advisers and shareholders. Work closely with your advisory team to address all of the various accounting and tax nuances associated with a business combination.

Jeff Haneline, CPA, is an assurance partner at Cohen & Company. He has over 17 years of experience in the investment company industry, including a former role in fund administration for a third-party service provider and experience working with large institutions. Haneline provides audit services to open- and closed-end mutual funds, exchange-traded funds, hedge funds, and related service providers.

Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this article is considered accurate as of the date of publishing. Any action taken based on information in this article should be taken only after a detailed review of the specific facts, circumstances and current law.



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