Massive Outflow From Stock Funds Has Wall Street on Edge

Will investors fleeing stock mutual funds be the next problem to hit Nasdaq?

That’s what some investment analysts were asking Friday as the Nasdaq composite index marked the one-year anniversary of its all-time closing high with yet another unsettling downward lurch.

What has Wall Street on edge is known as “capitulation,” a final frenzy of panicked selling that some analysts believe must occur before a bear market can end. With the Nasdaq down 59.3% from its peak on March 10, 2000, it’s a growing concern.

As one researcher put it, “the final capitulation could be much uglier” if mutual fund investors continue pulling cash out of stock funds as some unofficial estimates suggest they did in February. Volatile aggressive growth and technology funds could be among the hardest hit in such a scenario.

“What everybody dreads is a capitulation where it gets circular: The public pulls their money out, forcing fund managers to sell [stocks], which pushes prices down, prompting more people to sell, and so on,” said Carl Wittnebert, research director at Santa Rosa-based TrimTabs.com, which estimates mutual fund cash flows.

TrimTabs estimates that a net $13.4 billion was yanked from stock funds in February, which would be the largest monthly outflow ever and the first since August 1998, when investors were rattled by the Asian financial crisis. The Investment Company Institute, the industry’s main trade group, will release official February figures at the end of this month.

But Wittnebert said last month’s investor activity signaled only “an intermediate capitulation.”

“All-time record outflows in dollar terms [in February would] represent a degree of capitulation,” he said. “But at 0.3% of total fund assets, it’s not a particularly large portion--it’s not like people are rushing for the doors. If they do at some point, the final capitulation could be much uglier.”

Thus far, he said, investors have bided their time whenever the stock market swooned, he said, sniffing for a bottom rather than panicking.

“Cash piled up on the sidelines in February,” Wittnebert said, but then reversed course during the first five trading days in March, when funds took in a net $9 billion by TrimTabs’ estimate.

“There’s an anxiousness to step back in and purchase [beaten-down stocks],” said John Bollinger, a Manhattan Beach-based strategist who runs the Bollingerbands.com Web site. “Collectively, we just haven’t learned our bear market lesson yet.”

Thus far, fund companies have downplayed the significance of recent redemptions.

Janus spokeswoman Jane Ingalls, for example, said the firm’s retail funds were hit by outflows in February, continuing the pattern of recent months. But increased buying by institutional investors partly offset the redemptions, she said.

“Overall our outflows were modest,” she said. “This is not something that has affected portfolio managers in any way. Nobody has had to sell anything to meet redemptions.”

A Charles Schwab spokesman said the company’s stock funds had positive flows during February.

Still, in a move Morningstar analyst Christopher Traulsen called “a sign of the times,” one fund company known for its ultra-aggressive stock-picking has announced plans to reopen two funds that have been rocked by redemptions amid slumping performance.

Van Wagoner Emerging Growth and Van Wagoner Micro-Cap Growth, which were inundated with cash in 1999 amid stunning gains before being closed to new investors, will reopen Monday. Assets of both funds have fallen by about half in the last year through a combination of lower stock prices and net redemptions, Morningstar said. The funds are down 50% and 39%, respectively, year to date.

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* MARKETS HAMMERED

Nasdaq marked the anniversary of its peak with a brutal sell-off. A1

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Money In -- and Soon Out?

Monthly net cash flows to aggressive growth and sector stock mutual funds have been positive for most of the last two years, but some analysts fear the funds could be hit with significant outflows if performance keeps sagging.

Aggressive

January: $7.6 billion

Sector

January: $1.6 billion

Source: Investment Company Institute