Worried investors withdrawing funds

Mutual Funds

As the market goes so does the cash

May 02, 1999|By Bill Barnhart | Bill Barnhart,CHICAGO TRIBUNE

Cash redemptions are nagging equity mutual funds, except for a handful of giant funds focused on buying popular large-company stocks or Internet stocks. Many stock fund buyers, it seems, are just as fickle as direct stock investors in attempting to time the stock market and chase fads.

Most investors focus exclusively on funds' investment results, which in many cases have been disappointing enough this year. But the volatile fund cash-flow trend implies a second worry for those intent on investing for the long haul through mutual funds.

A stock-picking fund manager coping with persistent net redemptions -- more cash leaving the fund than entering -- faces a harder task in producing reasonable investment returns for loyal fund shareholders.

Increased portfolio turnover, which swells transaction costs and may increase capital-gains exposure for taxable-fund shareholders, is just one danger to investors who have not redeemed their shares. In the worst case, a manager must sell stocks owned because of well grounded investment appeal just to raise cash to pay redemptions.

Fund-industry officials maintain that educating investors about the wisdom of steady, long-term investing is the key to solving a chronic net-redemption problem. But the increasingly complex mechanisms fund companies use to distribute their shares complicate the process of reaching investors, let alone changing their behavior.

No-load mutual funds, an enormously popular investment concept, are sold directly to the public without a broker's sales commission or service, but the fastest-growing distribution vehicle for no-load funds is mutual fund supermarkets established by such brokerage organizations as Charles Schwab, Fidelity Investments and Jack White.

And the fastest-growing group of fund supermarket customers, in terms of dollars, are fee-based financial advisers. Supermarkets and fee-based advisers play an important role, but they distance the fund from the ultimate investor.

"I don't think there's any question that the velocity of funds is increasing," said Thomas Butch, president of Stein Roe Mutual Funds. "But we see only modest divergence (in investment patience) between someone who comes to us directly or someone who comes through Schwab."

In any event, "We can do our job best when assets are stable," said Victor Morgenstern, chairman of Harris Associates, sponsor of the Oakmark Funds. Oakmark distributes its funds' shares through the Schwab One Source mutual fund supermarket and through other second-party mechanisms.

In the nine months that ended March 31, the flagship Oakmark Fund, which pursues the out-of-favor value approach to stock-picking, suffered $2.3 billion of net redemptions.

"We are not the place for market-timers," declared Dennis Clark, a senior vice president for mutual fund relations at Schwab. Like other no-load fund marketplaces, Schwab has established rules to discourage hot-money investors and shun fee-based advisers who pursue market-timing strategies.

"It's not uncommon for a fund to refuse (buy) orders," Morgenstern said.

But the industry needs carrots as well as sticks. Morgenstern said he believes fund companies must make investors feel closer to the investment process, a throwback to the days when fund managers spoke directly to investors. Conference calls between fund managers and investors help, he said.

Schwab's Clark said his firm, in its effort to establish itself as a full-service investment firm, can direct e-mail to investors -- with their consent -- as one way to bridge the gap between funds and investors.

But more information is not necessarily the solution. "There is so much information that it can be overwhelming," Butch said. "We haven't seen the needle move dramatically in terms of the sophistication of investors."

And despite their best efforts, the fund industry realizes that its distribution schemes, designed to broaden its reach and garner ever more assets, have a dark side.

Morgenstern mentioned one possible problem -- a fee-based adviser using mutual funds who feels compelled to re-engineer a client's portfolio simply to justify his or her fee. A client paying an adviser an annual percentage of assets may say, "You did my asset allocation once. Why am I paying the fee this year?" Morgenstern said.

Pub Date: 5/02/99

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