Industry Colored by a New Impatience
Amid wild market volatility, disappointing mutual fund returns and the rise of online brokerages, more Americans are forsaking long-term stock investing for other strategies--including active trading and a shift of capital to other, safer assets. The challenge to the ‘buy-and-hold’ mind-set is growing, as this three-part report explains
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In the fall of 1996, at a time of unprecedented growth in the mutual fund industry, Vanguard Group founder John Bogle warned that there was an “ominous” trend developing.
The industry’s traditional emphasis on “buy and hold” investing was giving way to short-term thinking, Bogle said, as more fund companies accommodated people who wanted easy entry and exit.
The industry risked enticing investors “to use their mutual funds as vehicles for rapid switching, either for . . . market timing or for the purpose of jumping on the bandwagon of the latest hot fund,” Bogle said.
How prescient.
Today, the majority of the nation’s 77 million fund investors may still be buy-and-holders. But that patient strategy--made famous by the likes of Warren Buffett and Peter Lynch--while alive in the stock fund business, is not well.
Last year, investors pulled $534 billion out of stock funds, a 48% jump over stock fund redemptions in 1997, according to the Investment Company Institute. In the first two months of this year, redemptions were up 62% over last year’s pace--even as major stock indexes have continued to soar.
While new money is flowing into the funds at the same time redemptions are rising, those higher redemptions have sharply depressed the net sum of new cash entering stock funds: $159 billion in 1998, down from $220 billion-plus in both 1996 and 1997.
Redemptions are surging as fund investors, for any number of reasons, are opting not to hold their funds nearly as long as they did just a few years ago.
The average holding period for stock fund investors in the late 1980s was five years, if not more, according to industry estimates. Today, many fund companies believe it is down to three years or less. Some industry experts say it may be as low as 18 months.
“Investors are becoming less patient,” says Ken Gregory, editor of the No-Load Fund Analyst newsletter in Orinda, Calif. “Increasing numbers of today’s mutual fund investors remind us of channel surfers who, with remote control in hand, never watch anything for more than a few minutes.”
To be sure, the fund industry isn’t in grave danger. With assets of nearly $6 trillion--$3 trillion of that in stock funds--the business still holds a huge share of the public’s wealth.
Even so, the industry faces the potential for a worsening of the stock fund redemption wave, as the concept of buy-and-hold is pressured by three forces:
* The aging of fund shareholders. As longtime investors near retirement, more will begin to think about cashing out portions of their stock holdings, either to pay for living expenses or to move into less risky securities.
Over the last year, in fact, purchases of lower-risk bond and money market funds have zoomed even as stock fund inflows sank.
* Internal competition. There are nearly 13,000 funds to choose from, more than twice as many as five years ago. This at a time when the industry is having more difficulty attracting new customers.
Says Geoff Bobroff, an industry consultant in East Greenwich, R.I.: “We have hit a plateau in terms of reaching individual investors. We have reached the majority of households that can be cost-effectively reached.”
To increase market share, then, fund companies must convince customers at competing firms to dump their existing funds.
* External competition. In an era of fast-rising individual stocks but mediocre stock fund performance overall, funds are losing business to competing outlets, such as online brokerages that allow investors to trade individual stocks on their own--and very cheaply.
Over the last three years, while the benchmark Standard & Poor’s 500 index of blue-chip stocks has risen 28.1% a year, the average U.S. stock fund has gone up (I hate to say “just”) 17.2% a year.
No wonder folks like Annie Bonner, 39, are being lured away from funds by the hope of making more money in individual stocks.
Three years ago, the Irvine resident began contributing to her company-sponsored 401(k) retirement plan, directing her money into three T. Rowe Price stock funds. It was her first exposure to the stock market.
Two years ago, Bonner rolled her 401(k) account into an IRA with discount broker Charles Schwab. Then she came to a realization: “If I had taken all of the money I put into mutual funds and put it into decent stocks, I would have done way better than I did through my funds.”
Today, the vast majority of Bonner’s retirement money has been pulled from stock funds and invested in individual stocks--including IBM, Intel and a small Southland tech firm called MiniMed.
Of course, the concentration of market gains in a relative few big stocks in recent years has made investment success look easy for many individuals who’ve played that game. It’s foolhardy, experts say, to believe that it will be this easy going forward, especially when a major market bust occurs.
Bonner, however, argues that if the market collapses, mutual fund managers will be in the same boat she will--or worse: Fund managers, she notes, will be at the mercy of their investors, whereas she will at least still be in control of her portfolio.
Some fund investors who are moving large parts of their portfolios into individual stocks are still maintaining a buy-and-hold attitude with their remaining funds.
Jim Rapp, for instance, who began investing in the late 1980s through American Century stock funds, moved the bulk of his equity stake into individual stocks over the last three years.
Still, the 42-year-old Alexandria, Va., resident, who runs his own Internet consulting firm, maintains a long-term holding in a fund that tracks the S&P; 500 index.
He figures the index fund anchors his portfolio, giving him a degree of comfort as he buys and sells individual stocks on his own.
What about all that 401(k) money that’s supposed to be pouring into stock funds each month? It’s there. Indeed, if it wasn’t, the toll on the funds from the redemptions would be far greater.
In 1998, redemptions climbed to 20% of average stock fund assets, up from the 16% average annual rate between 1989 and 1996, according to Financial Research Corp., a financial services consulting firm.
As a percentage of new fund purchases, stock fund redemptions have been even more pronounced. For every new dollar investors put into stock funds each year between 1989 and 1994, 53.3 cents left each year, on average. In 1998, that figure climbed to 76.2 cents.
Does it matter to fund managers that cash flows have become less of a one-way street?
It can matter a lot. A fund manager who has to worry about wild swings in money into and out of his or her fund could, in turn, begin to focus on short-term results to satisfy impatient investors.
“Volatile cash flows make it tougher to manage a fund,” says Gregory. “The pressure to perform in the short run makes it much tougher for managers to do the right thing for the long term.”
Which in turn could lead to greater disappointment among investors over time. In other words, a classic vicious circle.
The problem for the fund industry is that some technology-driven trends only serve to strengthen the challenges to buy-and-hold:
* It’s simply easier to trade in and out of funds than ever before.
At the start of the decade, about 20 cents of every dollar invested in mutual funds was held in a tax-deferred retirement account such as an IRA or 401(k), ICI data show. Today, it’s approaching 40 cents.
Sure, these funds are great long-term savings vehicles. But inside these accounts we can shift out of and into funds with ease--without triggering taxes or trading costs.
Indeed, whereas only 4% of 401(k) plans allowed daily investment trading in 1989, more than 70% do now, according to a new Buck Consultants survey of 401(k)s.
“There’s no question in my mind that it’s much easier today than it was even two or three years ago to trade a fund,” says Jim Stratton at Stratton Growth Fund.
Investors in taxable accounts also find it easier to toggle between funds: An increasing number of us now are buying funds through so-called fund supermarkets, such as brokerage Charles Schwab’s OneSource program.
These supermarkets allow investors to comparison-shop for thousands of different funds, all in one place. If you aren’t happy with a fund you put into your shopping cart, all it takes is one phone call to put it back and buy another.
Switching out of a fund “should not be a casual decision,” argues Chuck Royce, founder of Royce Funds. “But today, you can wake up at 3:30 in the morning with a stomachache and pick up a phone to get out of a fund. We’ve got way too much convenience. Enough already.”
It was the supermarkets that Vanguard’s Bogle was so worried about in 1996--and they’ve only become more prevalent since.
* It’s emotionally easier for us to leave our funds.
You can thank intermediary relationships like 401(k)s and fund supermarkets for that.
Notes New York Life Benefit Services President Joel Disend: “If I buy my fund directly from the fund company, I pick up a phone and personally interact with that fund family. However, if I’m investing in that fund through my 401(k), I’m dealing with my 401(k) administrator. That’s who my relationship is with.
“As far as [401(k)] plan participants are concerned, the funds are commodities with different names on them,” he said.
David Castellani, senior vice president at Cigna Retirement & Investment Services, the nation’s third-largest 401(k) plan sponsor, says “there’s no question” that the inability of funds to forge meaningful relationships with 401(k) investors is having a real impact.
Last year, for example, investors pulled more money out of brand-name retail mutual funds in Cigna-managed 401(k) plans than they shifted in, favoring instead generic, low-cost institutional fund options.
* The wealth of information available to fund investors today encourages “flipping” and discourages staying put.
“It’s the magazines, it’s CNBC, it’s all the information on the Internet,” says No-Load Fund’s Gregory. “The availability of information really creates a temptation. These tools tempt people to trade their funds, since they highlight short-term performance.”
There’s clear acknowledgment from the industry of the problems that active fund trading produces.
Several fund companies, including Strong Funds and Montgomery Asset Management, have recently moved to impose redemption fees to penalize investors who pull money out too quickly. Invesco is following suit.
Others are going so far as to tell investors who flip in and out of portfolios to take their business elsewhere. In February, for instance, Vanguard closed its popular Health Care fund after an inordinate amount of money poured into the “hot” fund in just two months.
Yet many of these same fund firms have recently launched or improved their own fund supermarkets or brokerage services.
Some fund executives believe the rise in redemptions is temporary, and they may be right.
But after a decade of huge industry asset gains--and few questions asked by many stock fund investors--the numbers now betray a growing restlessness, the long-term impact of which is uncertain.
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Paul J. Lim can be reached by e-mail at paul.lim@latimes.com.
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Fund Stocks Become Laggards
Shares of most mutual fund companies have been poor performers over the last 15 months, which suggests the market is concerned about the industry’s growth prospects. Performance of a number of major stocks:
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12/31/97 Fri. Pctg. Stock Ticker price close chng. Phoenix Inv. Partners PXP $8.00 $9.44 +18.0% T. Rowe Price TROW 31.44 32.56 +3.6 Pimco Advisors PA 30.25 29.13 -3.7 United Asset Mgmt. UAM 24.44 22.00 -10.0 Affiliated Managers AMG 29.00 25.75 -11.2 Waddell & Reed WDR 23.00* 20.13 -12.5 Franklin Resources BEN 43.47 29.00 -33.3 S&P; 500 index 970.43 1,348.35 +38.9
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*Measured from initial public offering, March 1998
Source: Bloomberg News
