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Merrill Lynch scraps Net mutual fund

In a move that's a bad omen for the 30-odd Net funds that remain, the venerable company merges its Internet Strategies Fund into its Global Technology fund.

Even venerable brokerage Merrill Lynch can't keep an Internet mutual fund alive. Just a year after its Internet Strategies Fund was created, the investment bank plans to merge it into its Global Technology Fund.

Internet Strategies joins a growing number of Internet funds that have closed or shifted their portfolios. Merrill Lynch's closure of Internet Strategies is the highest profile termination of an Internet fund to date.

In a filing with the Securities and Exchange Commission Friday, Merrill said shareholders will vote on the Internet Strategies-Global Technology merger Aug. 31.

The Internet Strategies Fund made a big splash in March 2000 when it jumped into the scene with $1.1 billion raised in its two-week initial offering period.

But Merrill Lynch couldn't have picked a worse time to launch the Internet-specific fund. The Internet bubble began to deflate over the spring and summer, and finally burst last fall. In early 2000 there were 40 Internet mutual funds, but since then the number has dropped to about 30.

From its date of inception, March 20, 2000, through Thursday, Internet Strategies lost 71.6 percent. That's even worse than the average performance of the remaining 30 Internet funds, which were down 66.6 percent for the same period, according to data from Lipper Analytical, which evaluates funds.

The Internet Strategies Fund's merger partner, the Global Technology fund, which is run by the same manager, Paul Meeks, didn't fare much better. It lost 59.8 percent for the same period, as opposed to a decline of 54.6 percent for the average tech fund.

"Its just one of those unfortunate things that come with investing in a hot asset class," said Lipper Analytical analyst Don Cassidy. In 1999, there were just four Internet funds. By early 2000 that number had jumped to 40, creating an oversupply in a market that was to exacerbate the imminent drop in demand.

Merrill decided to jump on the bandwagon because it was tired of seeing money go to other Internet funds it was selling to meet client demand, analysts said.

There's a significant motivation for an investment bank like Merrill to start a fund branded with its own name. "The management fee, say three-quarters of a percent, or 1 percent on assets--that's a fair incentive to have a fund of your own, particularly if you're the size of Merrill Lynch," Cassidy said. Even given the enormous costs required to bring a fund to market, and the huge losses that the fund suffered, Cassidy is confident the venture was very profitable for Merrill.

Spot the difference
Merrill spokeswoman Christine Walton said the economic environment wasn't the main impetus to merge the funds. "About four or five months ago, the funds started to look similar," Walton said, because the dot-com meltdown reduced the supply of Internet stocks.

Indeed, the top 10 holdings of Merrill's Internet Strategies Fund are also found in other tech funds. According to the fund's annual report, Merrill's Internet Strategies Fund counted AOL Time Warner, Check Point Software, BEA Systems, Cisco Systems, Ariba, eBay and Oracle among its top picks. The fund's holdings were also weighted toward enterprise software (22.9 percent) and infrastructure hardware (14.9 percent).

Walton also said the Internet is just too pervasive to differentiate from the tech sector. When Merrill opened the fund, "we believed the Internet to be a viable, standalone subsector," said Walton, who also pointed out that the Internet has been adopted like the telephone.

Given what's been happening with other mutual funds, the death of Internet funds isn't surprising. Investors removed a whopping $20.6 billion from mutual funds last month, the largest one-month outflow ever, according to data from the Investment Company Institute (ICI), a mutual-fund trade group.

And Internet funds have been the hardest hit. Three out of 40 initial funds have already been liquidated, including The de Leon Internet 100, the Internet Index Fund and the Zero Gravity Internet Fund; and four have announced name changes to rid themselves of the dreaded word "Internet."

An Internet mutual fund "is just too hard of an item for brokers to sell to clients right now," Cassidy said.

But mutual funds that are run by a larger company usually tend to hold out longer than most. The demise of Merrill Lynch's Internet Strategies Fund is therefore an ominous sign for the 30-odd funds that remain.