HANOVER, NH (ETFguide.com) - In my last article, I demonstrated how ETFs have taken control of the high-end of the performance spectrum.  It's doubtful managers of mutual funds with a tiny investor base will compete soon, if ever.  Indeed, if you've invested with a small-manager fund don't be surprised if the trustees liquidate your account this year, or merge it into some big fund shop.

Many small funds are run by financial advisors for high net-worth individuals.  The advisors use their mutual funds as a way to accept small-fry money.  The current market decline has made these funds expensive to run; that is, their assets can't support their back-office operating costs.  Before closing the fund, advisors usually put the large accounts into SMAs (separately managed accounts) and give up on the rest.

Going forward, the public continues to choose new ETFs over new mutual funds.  Does anyone really expect the next bull market to run its offense through mutual funds?  ETFs are tax-efficient, focused, specific about what they do, low-cost, and can be bought or sold throughout the day.

A graph is worth a thousand words.  This chart below is updated from my last report on this market segment in April 2008. It takes a simple look at tiny mutual funds, ETFs, and the mutual fund industry.

The left-hand scale is for the Small Manager funds and ETFs.  Both began the period with around $450 billion in assets.  On the right-hand scale are all mutual funds, represented by the maroon line.  As the large mutual funds and ETFs assets have remained steady, the small manager funds have shrunk by about 40%. 

One reason all mutual fund assets haven't shrunk by 40%, like the stock market, is that money was shifted to money market and bond funds.  The $1 trillion that rushed into cash during November and December of last year created disjointed asset numbers for the large funds and ETFs, which you'll notice in the chart.  The  Small managers generally don't have those types of funds in their family line-ups.

Some small managers added funds in 2008, yet they still saw an 8% decline in the number of funds.  I estimate that the small managers are closing about $13 billion in funds per month, totaling about $156 billion in 2008.  Small funds have also lost about $50 billion in net redemptions. Want to see an example?

A small manager I picked randomly from my small manager group is Snow Capital Management.  They have 3 classes of the Snow Capital Opportunity Fund, A Shares (Nasdaq: SNOAX), C Shares (SNOCX) and Institutional Shares (Nasdaq: SNOIX)  The portfolio began in April 2006 and grew to a high of $255 million in April, 2008.  As of December, their assets are down to $120 million.  Even worse, the fund lost about 42% in 2008, badly trailing the Vanguard 500 Index Fund bellweather (Nasdaq: VFINX) by about 5%. 

If the market doesn't rise soon the institutional investors of such funds are going to wonder if it ever makes sense to invest in small mutual funds with high operational costs.  When the Snow Capital Opportunity Fund began in 2006 it had administration and accounting fees of about $34,000.  The fund is now running annual expenses for that service of $340,000.  When a fund's assets grow it doesn't make more paperwork.  But when they shrink, they're often subject to minimum fees. In the end, shareholders end up footing the bill. 

Many of the banks you read about perform these kinds of (once?) profitable services.  They would provide the funds with a low start-up teaser fee and then take a percentage of assets. But the tide has shifted. Managers of mutual funds with a small asset base are about to be pressed to lower their costs while the large service providers will need to cut unprofitable relationships.

Here are just ten small-manager funds entering a stressful 2009: Activa, Aegis Value, Bogle, Fusion Funds, Hillman Capital, Navellier, Oak Value, Pearl, Roxbury, and Utopia Funds.  I estimate that are at least 40 other small mutual fund managers scrambling to rationalize their business.

If you've aligned your money with a small or upstart mutual fund company, you have reason to be concerned. I encourage you to enter your mutual fund symbols into  fundanalyze.com's online database and see a list of 5 low-fee alternatives. You should have an exit strategy. 

If the market doesn't recover by April 2009, expect to see the first real decline in the number of mutual funds available.

Max Rottersman is a principal of Hanover Technology Group, LLC. His opinions don’t necessarily represent the views of ETFguide.com or Yahoo Finance.