Mutual fund liquidations, also referred to as "full closures," are never good news. Liquidation involves the sale of all of a fund's assets and the distribution of the proceeds to the fund shareholders. At best, it means shareholders are forced to sell at a time, not of their choosing. At worst, it means shareholders suffer a loss and pay capital gains taxes too.
Standard & Poor's, in a 2016 report on the performance of funds compared totheir index benchmarks, noted that nearly a quarter of all U.S. and international stock funds had been merged or liquidated in the then-past five years.
Most dead funds are merged into another in the fund family. This route is easier for shareholders because their money is immediately invested in a similar (and often more successful) fund.
The Thrill Is Gone
Still, liquidations do occur, usually after a fund has dropped in value. This forces investors who bought when the fund was more expensive to sell at a loss. Worse yet, the fund may have embedded capital gains, which can have an immediate impact on investors holding the fund in a taxable account. This occurs when a fund doesn't sell a stock that has risen in value since it was purchased.
For investors, this means that although the stock may have been purchased by the fund before some investors bought in, the tax liability for those gains is not passed on to investors until the stock is sold and the gains are realized and paid into current shareholders' accounts. This occurs because of the "mutual" ownership aspect of mutual funds. Therefore, when the fund is liquidated, the investor not only sells the fund for less than the purchase price but also still pays tax on capital gains that they did not get to benefit from. This can be particularly damaging to investors holding the fund in taxable accounts, as the taxes cannot be deferred the way they could be in a tax-deferred investment, such as a 401(k) plan.
Let the Good Times Roll
Funds are liquidated for a variety of reasons, with poor performance ranking as one of the primary causes. Poor performance reduces asset flows, as investors choose not to buy into a fund that isn't doing well. It also brings down the mutual fund management firm's track record. If the firm has five funds and four of them are doing well, closing the poor performer gives the firm a track record based on four successful funds.
Poor performance also results in bad publicity, which can lead to large redemptions. As the asset base falls, the costs of doing business increase. Funds operate on economies of scale, with bigger being better from a cost-savings perspective. As costs increase, it can become unprofitable to operate a fund.
If investors are losing money, the fund is likely to stay open as long as the fund can be operated profitably, but when the fund company starts to feel the heat, the fund is terminated. After all, fund companies are in business to make a profit.
The 'How Long?'Blues
Fund terminations are common, particularly among new funds. If a fund doesn't gain popularity and grow during its first three years, it is likely to close. Several hundred funds closed nearly every year during the late 1990s and the early 2000s. Niche funds are particularly vulnerable, as they are often invested in fads, or focused on such a small aspect of an industry that there is a risk the concept will never catch on with investors.
Signs that a fund is a candidate for closure include a big drop in performance that is sustained without recovery. A poor track record over several years is another warning. Because poor long-term performance simply isn't appealing to investors, heavy redemptions are another possible indicator.
When You're Down and Out
If you've got the feeling that your fund is going away, what should you do? There are different strategies for different funds. If you're invested in an open-end mutual fund, and the signs of the end are coming, it's time to head for the exit as fast as you can. When investors all want to sell a particular fund, the selling pressure tends to lower the fund's price. Getting out sooner rather than later can help you get a better price for your shares and salvage as much of your investment as possible.
If you are invested in a closed-end fund, look at the underlying assets. If the fund is selling at a premium, sell to maximize your payout. If the fund is trading at a discount, you may want to hold because you will get paid on the full value of the assets when the fund liquidates them.
The Bottom Line
Mutual fund closures are not extraordinary events. They happen all the time as part of the fund industry's natural business cycle. You can minimize your exposure to these occurrences by investing in funds with long track records of success and carefully monitoring your exposure to niche products. When a closure occurs, it's not the end of the world. Take appropriate action, learn from the experience, and redeploy your assets to keep your long-term investment goals on track.
FAQs
Mutual fund liquidations, also referred to as "full closures," are never good news. Liquidation involves the sale of all of a fund's assets and the distribution of the proceeds to the fund shareholders. At best, it means shareholders are forced to sell at a time, not of their choosing.
What will happen when a mutual fund is closed? ›
When Mutual Fund company shuts down, investors are returned their funds based on the last available NAV before winding up. To know more visit our website now.
What happens when a closed-end fund liquidates? ›
A term fund has a specified termination date at which time the fund's portfolio is liquidated. Investors who own shares when the fund terminates receive a cash payment equal to the NAV per share at that time. This NAV may be higher or lower than what the investor originally paid.
Are mutual funds easily liquidated? ›
Mutual fund houses usually keep cash reserves to cover investor redemptions so they aren't forced to liquidate any portfolio holdings at inopportune times. Mutual fund products essentially come with two exit options – voluntary exit at any time during the term of the fund or redemption upon maturity or after lock in.
When should you liquidate mutual funds? ›
The way to do that is to compare its performance with its peers. If a fund consistently underperforms its peers for an extended period, say three years or more, it might be best to exit that mutual fund. Avoid rash decisions based on short-term fluctuations in performance, like the last six months or a year.
What are the risks of a closed-end mutual fund? ›
Risks of owning closed-end funds
This can influence the fund's NAV and its premium or discount. But typically, the bigger risk is closed-end funds' potential use of leverage (i.e., borrowed money). That's how they can offer yields of 7% or more. Regulations allow leverage of up to 33%.
Is it good time to exit mutual funds? ›
When it comes to equity, it is very important that, especially when you are thinking about long-term goals, you want to exit as soon as you have 2-3 years left approaching your goal and there are just 2-3 years to get there.
What are the downsides of closed-end funds? ›
Investing in closed-end funds involves risk; principal loss is possible. There is no guarantee a fund's investment objective will be achieved. Closed-end fund shares may frequently trade at a discount or premium to their net asset value (NAV).
Can a mutual fund collapse? ›
Funds are liquidated for a variety of reasons, with poor performance ranking as one of the primary causes. Poor performance reduces asset flows, as investors choose not to buy into a fund that isn't doing well. It also brings down the mutual fund management firm's track record.
Can you make money with closed-end funds? ›
Depending on a closed-end fund's underlying holdings, its distributions can include interest income, dividends, capital gains or a combination of these types of payments. In some cases, distributions also include a return of principal, sometimes referred to as a return of capital.
The chances of your mutual fund investment value going to zero are practically almost impossible as it would mean that all the assets in the fund's portfolio will have to lose their entire value. However, the returns from a fund can go to zero or even become negative.
Has anyone lost money in mutual funds? ›
One of the prominent reasons for mutual fund loss is a need for more knowledge about the investment options and market. Individuals who invest in mutual funds without proper research often end up in a situation where they have to face a loss of money.
Should I cash out my mutual funds? ›
If you have money in mutual funds, using some of it to pay off debt, especially debt with high interest rates, might seem like an attractive option. But cashing in your mutual funds isn't always the best way to become debt-free, and, depending on how you hold those funds, you could end up with a big tax bill.
What is the 30 day rule for mutual funds? ›
The 30-day rule is a guideline that applies to mutual funds. It states that if you sell shares of a mutual fund and then buy them back within 30 days, the transaction is considered a “wash sale” and you cannot claim a loss on your taxes for that sale.
Should I get out of mutual funds now? ›
However, if you have noticed significantly poor performance over the last two or more years, it may be time to cut your losses and move on. To help your decision, compare the fund's performance to a suitable benchmark or to similar funds. Exceptionally poor comparative performance should be a signal to sell the fund.
Is it good time to withdraw money from mutual fund? ›
The right time to redeem mutual funds depends on your financial goals and the performance of the fund. You should redeem your units when you are close to achieving your goal or when the fund is not meeting your expectations.
What happens to your money when a fund closes? ›
Liquidation involves the sale of all of a fund's assets and the distribution of the proceeds to the fund shareholders. At best, it means shareholders are forced to sell at a time, not of their choosing. At worst, it means shareholders suffer a loss and pay capital gains taxes too.
What does it mean when a mutual fund has a closed status? ›
Understanding a Closed Fund
A closed fund may stop new investment either temporarily or permanently. Closed funds may allow no new investments or they may be closed only to new investors, allowing current investors to continue to buy more shares. Some funds may provide notice that they are liquidating or merging.
What is the penalty for closing a mutual fund? ›
Some mutual funds charge fees if you decide to sell your shares. For instance, you're responsible for a percentage of the total amount of shares you're selling. This is known as a back-end load fee. Often a flat fee, the back-end load tends to decrease over time.
What happens when a mutual fund closed to new investors? ›
These closed funds no longer accept money from new investors and operate only with their current assets and new investments from existing shareholders.
