Flow of money doesn't always tell where tide is going

Mutual funds

September 07, 1997|By CHICAGO TRIBUNE

Reports that trace money flows into and out of mutual funds seemed to suggest recently that investors have developed nervous trigger fingers in this volatile market climate.

Many investors believe fund investment and redemption data give them an important signal for timing investment decisions. Professional market-timers also follow fund-flow information. But turning short-term fund-flow data into self-fulfilling prophecies can be misleading and costly.

After the Dow Jones industrial average dropped 157 points on Aug. 8, the five-day trading period that ended Aug. 13 showed the biggest weekly net outflow of funds from equity mutual funds so far in 1997.

According to California-based AMG Data Services, which tracks flows, equity funds (which have more than $2 trillion in assets) suffered $827 million in net redemptions over a five-day period that saw the Dow average fall 259 points, or 3.2 percent.

The only other time this year in which AMG recorded net withdrawals from equity funds was the five-day trading period ended April 2, when a net $40 million left equity funds near the end of a spring stock slump.

Robert Adler, president of AMG, warns against extrapolating from a few weeks of fund-flow data. Fund flows often rebound strongly from brief slumps, he noted. "It's premature to read too much into this," Adler said after releasing the Aug. 13 data.

How right he was. The AMG report for the week ended Aug. 20, after the Dow's 247-point loss Aug. 15, showed the greatest net inflow into stock funds since the first week of the year: $6.6 billion was pumped into equity funds as the market recovered boldly from the Aug. 15 scare.

What's more, the latest evidence on redemptions has been highly concentrated in aggressive growth funds and funds specializing in small-company and emerging-country stocks, he said.

In the week ended Aug. 13, investors redeemed a net $889 million of small-cap fund shares, equal to 0.6 percent of the small-cap universe, but just $157 million of large-cap fund

shares, equal to 0.06 percent of the large-cap universe. Investors redeemed shares heavily in Asia funds for six weeks in a row this summer, after currency troubles in Thailand, Malaysia and Indonesia, but Asia funds are a tiny fraction of total funds.

The broad diversity of equity fund categories means that aggregate data about fund flows can be a poor stock market indicator.

Almost by definition, small-cap funds and emerging country funds will experience more volatile flows, involving proportionately greater amounts of dollars than large-cap funds. Investors in risk-ier funds tend to be more trigger-happy.

Making an investment decision about, say, a Standard & Poor's 500-stock index fund based on volatility in small-cap fund cash flow is a bit like taking your umbrella to work in Chicago because it's raining in Dallas.

Yet flow-of-funds data may lead to such behavior. In the week ended Aug. 13, small-cap stock prices, as represented by the Russell 2000 index, fell far less sharply than the Dow average, even though small-cap funds suffered far greater net redemptions than blue-chip funds.

On Aug. 15, when the AMG data for the week ended Aug. 13 hit news wires, the Dow plunged more than 3 percent but the Russell 2000 fell less than 1 percent.

Many factors influence stock prices, of course. A weakening dollar and a profit warning from consumer products giant Gillette also spooked the market on Aug. 15. But one interpretation suggests that market timers made sweeping judgments about total demand for stocks based on the latest weekly fund-flow data, although the redemptions were concentrated in a few sectors.

While big-picture numbers can be misleading, you would be smart to keep up to date on the flows into and out of your own funds.

It's well known that actively managed funds that attract too much money too fast can become hamstrung as the manager attempts to put new-found money to work. Funds can grow beyond the ability of the manager to execute the strategy you thought you were getting when you bought shares in the funds.

On the downside, the problem can be worse. Although most funds can borrow quickly to meet net redemptions without distress sales of securities, a quick, heavy rush of redemptions can force a fund into untimely sales.

Moreover, taxable investors in actively managed funds can lose big-time when heavy redemptions hit this time of year, before the fund's annual year-end distribution of capital gains, notes Thomas Plumb, a fund manager at Thompson Plumb & Associates in Madison, Wis. Fewer shareholders and fewer shares outstanding mean that the remaining shareholders take TC proportionately bigger tax hit when capital gains realized by the fund throughout the year are distributed, he said.

If you have a taxable account with a high-turnover mutual fund, you don't want to be the last one out when redemptions surge.

Pub Date: 9/07/97

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