A fund company would put a fund up for liquidation only if the fund has experienced poor performance for a substantial period of time. Poor performance affects not only fund shareholder returns but also the track record of the fund company. It lowers the average return for the entire fund family, and likely causes negative publicity to other funds within the fund family. To save one fund from ruining the fund company's reputation, fund liquidation may seem to be the right choice.
A poorly performing fund can become inoperable sometimes as a result of increased shareholder redemption. A fund that fails to deliver the expected returns will keep losing investors over time. As more fund shareholders withdraw money from the fund, the fund's asset base comes down smaller and smaller, which directly affects the amount of fund fees charged as a percentage of the total assets by fund management. Without enough management fees to cover fund expenses, fund operations would not be profitable, and fund liquidation becomes the only option.
A fund merger prevents the selling of the entire fund holdings on the open market, and better preserves the fund value for fund shareholders. But it may be difficult to find a truly compatible fund for the merger. Fund companies often create a family of funds that each have their own investment objectives and portfolio strategies to meet various investor demands. Merging a fund with another fund that has a different investment focus may negatively affect shareholders of the fund being liquidated. For example, a new, large-cap fund may not fit the needs of the shareholders whose liquidated fund was originally small-cap oriented.
To liquidate a fund, the fund company may choose to sell the fund's assets outright if there isn't a well-fitting fund to merge into, and can then distribute sales proceeds to fund shareholders. Depending on what is in the fund's portfolio holdings and the market trading conditions at the time of the sale, the fund may be forced to sell its holdings at a loss. Securities that are not widely traded may be hard to sell, especially when a fund dumps its often large holdings at one time. Unless the fund company arranges the asset sales in an orderly manner, shareholders may incur investment losses from a fund liquidation.