Why fund mergers often hide massive loss

When two mutual funds merge, the official explanation usually sounds benign: “portfolio rationalization,” “operational efficiency,” or “aligning investor interests.” To retail investors, it feels like routine housekeeping in a complex industry.

But scratch beneath the surface, and fund mergers often serve a darker purpose: to quietly bury underperforming schemes, conceal massive losses, and protect AMC reputations. Instead of acknowledging failure, AMCs fold a weak fund into a stronger one, diluting the damage across investors who may not even realize what they’ve absorbed.

This article explores how fund mergers work, why they’re often used to hide losses, and what it means for everyday investors.

How Fund Mergers Work

1. Regulatory Approval

   • SEBI (in India) or the SEC (in the US) must approve mergers, but the rationale is usually taken at face value.

2. Unit Conversion

   • Investors in the merging fund get units of the surviving fund, based on prevailing NAVs.

3. NAV Neutrality Claim

   • Officially, investors’ value is unchanged. In practice, they inherit bad assets from the merging fund.

4. Post-Merger “Stability”

   • Loss-making schemes disappear from public performance records, protecting the AMC’s track record.

Why AMCs Merge Funds

1. To Bury Poor Performance

• A failing small- or mid-cap fund is merged into a better-performing scheme.

• Future fact sheets only show the surviving fund’s track record, erasing the evidence of failure.

2. To Hide Massive Losses

• If a fund has toxic or illiquid assets, merging it into a larger fund dilutes the exposure.

• Retail investors in the stronger fund unknowingly absorb these risks.

3. To Maintain Fee Flows

• Instead of letting investors exit failing schemes (shrinking AUM and AMC fees), a merger locks investors into the surviving entity.

4. To Game Performance Rankings

• By eliminating weak funds, AMCs boost their overall category rankings, making marketing easier.

Case Studies

1. Franklin Templeton Wind-Up (2020, India)

• While Franklin opted for outright closure instead of merger, the episode highlighted why AMCs sometimes prefer mergers: closure requires admitting losses, while mergers bury them quietly.

2. HDFC AMC Mergers (2018–19, India)

• Several underperforming equity funds were merged into stronger peers during SEBI’s categorization exercise.

• While presented as “regulatory compliance,” analysts noted it conveniently erased poor historical performance from public view.

3. Global Example – U.S. Fund Consolidations

• Morningstar data shows that in the U.S., hundreds of funds disappear each year via mergers or liquidations.

• Many of these are chronic underperformers, merged into bigger siblings to clean up AMC track records.

How Losses Get Hidden

1. NAV Arithmetic

   • Loss-making assets are absorbed into a larger pool. On paper, the NAVs adjust neutrally, but in reality, stronger-fund investors now hold weaker assets.

2. Performance Track Record Reset

   • The bad fund’s history disappears from screens. Only the surviving fund’s (better) performance remains in databases.

3. Portfolio Dilution

   • Toxic or illiquid holdings (like stressed debt papers) get quietly blended into a bigger fund, making them less visible.

4. Communication Spin

   • AMCs emphasize “synergies” or “efficiency,” burying the fact that the real motive is to mask losses.

Why Regulators Allow It

• Operational Efficiency Argument: AMCs claim too many overlapping schemes confuse investors.

• Compliance with Categorization: SEBI’s 2017 categorization exercise gave AMCs a perfect excuse to merge weak funds under the guise of “simplification.”

• Lack of Investor Pushback: Most retail investors don’t question mergers, assuming they’re routine.

Consequences for Investors

1. Inherited Risks
   Investors in the surviving fund may unknowingly inherit junk assets.

2. Dilution of Strategy
   A focused fund may suddenly have its strategy diluted after absorbing another.

3. False Perception of AMC Strength
   The AMC appears to have fewer “bad apples,” masking true competence levels.

4. Weakened Transparency
   Investors lose visibility into how much value destruction actually happened.

Lessons for Investors

1. Track Fund Histories
   Watch which schemes disappear. If your AMC frequently merges funds, it’s a red flag.

2. Scrutinize Portfolio Shifts
   After a merger, study the new portfolio to see if risks have increased.

3. Beware of Marketing Narratives
   Phrases like “rationalization” and “efficiency” often mask failure.

4. Diversify Across AMCs
   Don’t depend on a single AMC—especially those with a history of mergers to hide poor performance.

Ethical Reflection

At its core, using mergers to bury losses is a breach of fiduciary duty. Instead of admitting mistakes and allowing investors to exit transparently, AMCs spread damage across unsuspecting holders. It protects the AMC’s image but erodes retail trust.

The ethical duty of AMCs should be honesty: disclose poor performance openly and let investors decide, instead of quietly sweeping losses under a bigger carpet.

Conclusion

Fund mergers often hide massive losses under the polished narrative of efficiency. By absorbing weak schemes into stronger ones, AMCs mask underperformance, protect track records, and keep fee streams intact—all at the expense of investor transparency.

For regulators, the challenge is to demand clearer disclosures about why a fund is merging and what risks are being absorbed. For investors, the lesson is vigilance: when your fund merges, don’t just glance at the new name—scrutinize what’s been smuggled into your portfolio.

Because in the mutual fund world, sometimes the neat word “merger” is just code for concealing failure.

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