Investors relentlessly poured money into stock mutual funds despite a yearlong decline in stock prices – until last month.
On Friday, Trim Tabs, a Santa Rosa, Calif., research firm, said investors yanked an estimated $13.4 billion out of stock funds in February as the Nasdaq slumped 22.4%. It was the first month of redemptions since August 1998.
Why have investors waited so long? And if they keep selling, could it prolong the bear market?
Some experts say investors have learned to stay on course for the long haul. They’re not going to be shaken out of their strategy just because the market goes down.
But there’s alarm in other circles. Some technical analysts see continued buying as a sign of dangerous complacency that may mean the next bull market is still a long way off.
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Image: Fund Investors Keep Buying
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"The structure of the market is different now," said John Rea, chief economist for the Investment Company Institute, a trade group. "A lot of money comes in from retirement plans. Individuals can reallocate their holdings, but in a retirement plan there’s a tendency not to do that."
About a third of mutual fund holdings are in retirement accounts such as IRAs and 401(k)s. The proportion has been steadily rising. This retirement money has been a reliable source of new money for the market.
The prospect of mass redemptions worried the Federal Reserve enough that it ordered its staff to research the topic. The Fed worries about what would happen if the market cracks open and fund shareholders head to the exits. Managers would be forced to sell massive amounts of stock to pay off investors. That could drive stock prices lower.
Mutual funds own about 20% off all the stock outstanding. So they are among the biggest players in the market each day.
The study, published in December, says that scenario is unlikely to play out. Managers have enough cash to meet redemptions and often have bank credit as a backup. Besides, except for brief periods, such as a few days after the October 1987 break, fund investors don’t panic. Outflow the past 13 years has been because investors aren’t buying enough to offset normal redemptions.
The Fed researchers also spotted an interesting trend.
Over the past two decades, mutual fund investors have been less inclined to sell when the market drops. After the October 1987 market break, there was net outflow from funds for 16 of the next 18 months, even though the market was recovering.
In the 1990 bear market, there were only two months of net outflow. After the sharp, but short, 1998 bear market, outflow lasted only a month.
This time, despite a year of declines, there wasn’t been a single month with net outflow – until now.
February’s decline amounted to just 0.3% of fund assets, less than the 0.4% of August 1998 and 3.09% of October 1987.
Investment Company Institute data, reported with a month lag, are more closely watched than Trim Tabs’. Still, it’s an early indication that fund investors may finally be getting nervous about the market.
The Fed researchers think the trend toward continued inflow amid market slumps is a good sign.
"Shareholders who held retirement accounts were generally focused on investing for the long term," their report says. "Fund flow was becoming less sensitive to stock price changes."
To Tim Hayes, research director for Ned Davis Research, mutual fund flows reveal investors aren’t as worried as they should be.
"It is showing there hasn’t been that capitulation yet out of stocks," he said. "It suggests a lingering complacency and a belief that the market will come back. We have been accustomed to not having to worry about declines as being prolonged."
He thinks if the market advances from here, it’s not likely to go far before disappointment sets in.
In some respects, investors may be signaling a more cautious tone. A year ago, they were interested only in such aggressive investments as tech funds. Now they’re starting to favor conservative funds, like those with bonds.
"In the first couple of months this year, we’ve clearly seen that people are a little reticent about the market. There’s some concern about the economic outlook," said Mo Shafroth, spokesman for Charles Schwab.
Schwab, which operates a giant supermarket of 3,740 funds, noticed that in January 2000 its investors preferred stock funds 3-to-1 over bond funds. The next month, the ratio was 50-50. Deposits in money market funds hit a record in January 2001 of $4.8 billion.
At Fidelity Investments, the nation’s biggest fund group, the situation is similar.
"For the better part of last year, investors were interested in the hottest, most aggressive growth funds to the exclusion of everything else," said spokeswoman Anne Crowley. "Starting in December, we saw a broadening of their interests to include bonds, money market funds. They are looking more at growth-and-income and balanced funds."
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