Yesterday I wrote about the mutual fund cash position data that the Investment Company Institute (ICI), the mutual fund trade association, provides on its website. Today’s post is about the general market situation that the overall ICI data portray.
A continuing (and mistaken, I think) quest for safety
The data show very clearly the effects of the market downturn, and the differing impacts of the financial crisis on stocks and bonds. They demonstrate that fund holders are very focused (closing the barn door long after the livestock have escaped, in my opinion) on preserving the value of their capital rather than thinking about enhancing their wealth or achieving capital gains.
Investors began to take money out of stock funds in June 2008 and continued to do so every month–except for January 2009–through the bottom of the market in March of last year. Redemptions were the largest in September-October 2008. Aside from those two months, the heaviest withdrawals occurred at the absolute bottom in February-March 2009. This, unfortunately, is the usual pattern for many individuals: in at the top, out at the bottom.
Five months of net inflows followed, almost replacing the dollar amount taken out in February-March. Since then, the pattern has been one of mild redemptions, again excepting January, a month when many retirement plans make significant contributions.
domestic vs. foreign
Since the market turn, the pattern of money flows has been very different for domestic and foreign stock funds. Foreign funds have had ten straight months of money inflow (February looks to be #11, but final data aren’t in as I write this). US-only funds, on the other hand, had inflows through July but have seen pretty steady redemptions since then.
The bond fund story makes much better reading, for fund management companies at least. Bond funds, too, had redemptions in 2008. But they lasted only four months, from September through December. Only one of them, October, saw large outflows. And even during this month, outflows were far less than withdrawals from stocks.
Since then, bond funds, both taxable and municipal, have enjoyed large inflows every month.
The dynamics of stock fund flows
ICI also provides information on the gross movements of money in and out of stock fund, in addition to the net data I’ve written about above (similar data aren’t available for bond funds, though.).
This under-the-hood look shows that the stock fund situation is more complex than the net data suggest.
In December 2009, for example, stock funds had net outflows of $3.5 billion. But this was comprised of $95.6 billion of inflows and $97.9 billion of outflows. There were also $13 billion of exchanges into stock funds from other types of investments under the umbrella of the same mutual fund organization, and $14.1 billion of exchanges out.
My take on what’s happening
There aren’t enough data from the ICI to have a lot of confidence in any interpretation. We know three things for certain, however:
–there’s a substantial shift by investors away from domestic-oriented stock funds toward foreign or global (US + foreign) funds,
–there’s also a shift going on away from mutual funds toward ETFs, and
–there’s immense churn by investors of their stock mutual fund assets. At the moment, stock fund gross redemptions are running at a yearly rate of about a quarter of the total assets. That’s about twice the rate I would regard as normal.
Why is that?
I think we’re going through a period of major disillusionment with mutual funds and mutual fund companies. This may be an event parallel to what happened after the crash of the stock market in October 1987, after which investors made a substantial shift in preference away from individual stocks and toward mutual funds.
What prompted this was that in the aftermath of the decline, NYSE “specialists” (that is, monopoly market makers) seemingly abandoned their obligation to promote market liquidity and started making much less attractive bid-asked spreads. Individuals placing market orders would receive executions that could easily be 5% away—invariably in an unfavorable direction–from the last trade they saw before placing the order. People blamed their brokers for these trading losses. I think the resulting atmosphere of distrust triggered a decades-long shift away from investing in broker-recommended individual stocks–and toward mutual funds. Of course, there were other reasons along the way–high fees, poor service, conflicts of interest–but I think the essential break came after Black Monday.
Today’s disillusionment is a bit more benign–not that mutual funds and mutual fund advisors aimed to do harm, but that they didn’t make money for their clients, or protect them from losses, like they were supposed to. This realization is at least partly behind the high level of redemptions and the shift to ETFs.
I also think Baby Boomers are just starting to come to grips with the fact that they haven’t been paying much attention to their retirement planning. The recent market decline has brought home to Boomers the fact, unlike our parents, we do not have the support of defined benefit retirement plans, so what our 401ks and IRAs earn really count for a lot.
We have not only taken on the risk of funding our own retirements, but are also responsible for how our retirement assets are invested. Few of us know the first thing about what to do. All we as a demographic have figured out so far is that we don’t want the status quo. So we’re changing what we own.
That’s not much of a strategy. The next step is to take responsibility for your own investment outcomes and start educating yourself about stocks and bonds. In other words, I guess, read my blog.
2. A more technical note: I’ve been hired a couple of times to turn around mutual funds that have had substantial periods of underperformance. One of the major things I’ve learned from these experiences is that when investors in a stock fund are deeply under water, they are so traumatized by the experience that they invariably redeem their shares.
Some do so quickly, to make use of the resulting tax loss, and reinvest in similar assets. Most, however, will hold on doggedly until they return to breakeven. Then they’re gone forever. Yes, this latter behavior makes no economic or financial sense. But it’s what people do. And that’s what I suspect is also partly behind the churn in stock mutual fund purchases and sales—a 70% rise in stocks over the past twelve months has brought investors who bought in 2004 or 2005 back to breakeven and they’re cashing in their chips. Where are they going? if the aggregate numbers are a good guide, to bond funds–a move whose logic escapes me.