New Fund Money Going to Bestsellers

The mutual fund industry is expected to release figures later this week showing that individual investors are putting large amounts of new money to work in stock and bond funds, something they’ve been reluctant to do for a while.

By one preliminary estimate, investors poured roughly $27 billion into stock and bond funds in March and are on track to invest about the same amount in April. Official figures for March from the Investment Company Institute, the industry’s chief trade group, will be announced in a few days.

However, the latest batch of numbers mask some disturbing trends for the industry overall.

Perhaps most worrisome is that only a handful of funds and fund companies are enjoying the lion’s share of that new money.

For the first quarter of 1999, the 25 best-selling funds accounted for roughly 96% of the quarter’s net new stock fund and bond fund investments, according to Financial Research Corp., a Boston-based consulting firm.

In other words, more than 10,000 other funds fought for the remaining 4%.

For the first quarter of 1998, by contrast, the 25 best-selling funds accounted for just 35% of all net new inflow to stock funds and bond funds.

What’s more, just five fund companies--Vanguard Group, Janus, Fidelity, Pimco and Alliance Fund Distributors--accounted for virtually all the $42.1 billion in net new investments during the 1999 quarter.

At the same time, nearly half of the nation’s 636 mutual fund firms saw net redemptions during the first quarter of this year, up from the 26% of the first quarter of 1998, according to FRC.

Just as stock market leadership has narrowed to a handful of large growth companies in recent months, fund flows “are now very, very narrow,” says Bill Dougherty, an analyst with the Boston-based mutual fund consulting firm Kanon Bloch Carre.

In general, investors are putting money only into the best-performing funds, such as Janus Twenty and Vanguard Index 500, each of which contains a large number of growth stocks.

“Five years ago, people knew about the hottest funds,” Dougherty says. “But they didn’t chase them. Today there’s more press about the hottest funds, so there’s more awareness, and people tend to follow the leaders.”

So far this month, it appears the narrow fund flow trend is holding.

The Santa Rosa, Calif.-based research firm Trimtabs.com says that on an average day during the first quarter of this year, slightly less than half the funds it tracks reported net inflows. And in April, it’s been much the same. On an average day this month, only 47.3% of the funds Trimtabs follows saw net inflows.

“It’s not a good sign when less than half of all funds are seeing inflows,” says Carl Wittnebert, Trimtabs’ director of research.

The concentration of flows into a small number of funds is obviously bad news for those funds that don’t get the money. Funds experiencing net redemptions are often forced to sell stocks in order to meet those redemptions, which could trigger tax obligations and hurt overall fund performance, and thus the fund’s attractiveness to investors.

But it’s not necessarily a picnic for the handful of actively managed funds getting all that new money. A suddenly ballooning asset base can force a fund to invest in second-choice stocks or even in cash, which could drag down returns.

This is why some fund companies choose to close their hottest funds.

In fact, in recent weeks, two of the nation’s top-selling funds, Janus Twenty and Vanguard Health Care, recently shut their doors to new investors. Janus officials cited the difficulty in putting so much new money to work at once in the stock market.

Geoff Bobroff, an industry consultant in East Greenwich, R.I., says the fund flow trends reflect the industry’s recent difficulty in attracting new investors. This could lead to even more of the consolidation that has been going on of late among fund companies.

“We’ve been flattening out for the last five years as an industry,” he says. “We’ve been plateauing.”

Bobroff adds that the picture may be even bleaker than the statistics indicate, since 401(k) plan participants often invest more money at the beginning of each calendar year than at the end.

“From a business standpoint, this could be a predictor of future consolidation in the industry,” Bobroff says, or even downsizing.

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The Lion’s Share

A relatively small number of mutual funds drew almost all the net new money invested in stock and bond funds in the first quarter of 1999, leaving more than 10,000 funds fighting for the remainder. This is a turnaround from last year, when the best selling funds got little more than a third of new investments.

First-Quarter 1998

25 best-selling mutual funds: 35%

All other mutual funds: 65%

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First-Quarter 1999

25 best-selling mutual funds: 96%

All other mutual funds: 4%

Source: Financial Research Corp. of Boston