Play-it-safe investors missing out on stock fund growth
IN the investment world, lessons sometimes can be learned too well.
Burned by the stock market’s plunge of 2000 to 2002, many individual investors have since stuck with a conservative portfolio strategy.
Now, after 4 1/2 years of rising share prices, some people ought to be wondering whether they’ve been too conservative for their own good.
The cautious mood that has marked this decade shows up in small investors’ approach to mutual funds.
U.S. stock market indexes hit or neared record highs in the first half of this year, but they did so without much help from fund investors, who’ve had relatively little appetite for domestic stock funds for the last two years.
The single most popular fund category this year is as dull as its name: intermediate-term bond funds, which invest largely in conservative corporate and government bonds.
On the risk scale, that’s light-years away from the technology-focused funds that were the ill-fated darlings of small investors at the peak of the late-1990s bull market.
Robert Bruce Woodcox, a 59-year-old ghostwriter of fiction and nonfiction books, says he was day-trading stocks in the 1990s. Today, he says, the riskiest thing in his portfolio is the Schwab Yield Plus bond fund, which holds short-term government and corporate IOUs.
The fund’s annualized yield is about 5.5%, and its share price, $9.67 on Friday, hasn’t changed much; in the last year it has kept within 2 cents of that figure.
In his day-trading period, “I made a lot of money and I lost a lot of money,” says Woodcox, who lives in Corona del Mar. “That stays with you for a long time.” The experience accounts for his hankering to protect principal, he says.
Still, asked what he’s doing for growth in his portfolio -- at 59 he could easily live 20 or 30 more years, I reminded him -- Woodcox admitted he has been thinking more about that issue.
He isn’t likely to get much growth from his bond fund. That isn’t the job of bonds.
Some fund-industry data suggest Woodcox has plenty of company in the play-it-safe camp:
* Net new cash inflows to domestic and foreign stock mutual funds totaled $84.1 billion from January through May, down 31% from the $121.3 billion in the same period of 2006, according to the Investment Company Institute, the fund industry’s trade group.
Net cash inflow totals are fund purchases minus redemptions by investors who are selling out.
* While stock funds took in fewer dollars, bond funds surged in popularity. A net $79.8 billion in fresh cash flowed in during the first five months of this year, nearly four times the $21.1-billion inflow in the year-earlier period.
* Money market funds, which invest in very short-term IOUs and are designed to have virtually no risk of loss, took in more than either stock or bond funds. The net cash inflow to money funds was $94.3 billion in the first five months, up from $16.2 billion in the year-earlier period, although money fund investors include companies and institutions as well as individuals.
To put those numbers in perspective, stock fund assets total about $6.6 trillion, bond funds hold $1.6 trillion and money market funds hold $2.5 trillion.
In part, the ebbing cash flows into conventional stock funds reflect the rise of exchange-traded funds, which track broad or narrow market indexes and allow investors to better customize their stock portfolios. ETFs have mushroomed in popularity in recent years.
But add in ETFs and the picture doesn’t change: Total net cash inflows to conventional and exchange-traded domestic stock funds lagged behind bond fund inflows in 2006 and are doing so again this year, according to Financial Research Corp., which tracks fund data.
It’s Financial Research’s data that show intermediate-term bonds as the single bestselling category of conventional funds and ETFs this year, with a net cash inflow of $32 billion in the first five months, double their intake in the same period of 2006.
One explanation for the demand for bond funds is investors’ growing use of so-called target-date mutual funds in retirement savings plans. Target-date funds invest in other stock and bond funds in a mix designed to shift toward bonds as the investors near retirement.
Because bonds offer much more stability than stocks, it also makes sense that baby boomers like Woodcox would be turning more toward them as they approach retirement. That portfolio “rebalancing” may be a key factor in the shift toward bond funds.
The question is whether some investors are going too far, trading too much future growth in favor of near-term portfolio stability.
Another element of portfolio rebalancing has been the tilt toward foreign stock funds in recent years. Many U.S. investors ignored foreign markets in the 1990s. No more.
On average, foreign stock funds have outperformed domestic funds every year since 2003, and that streak continues this year. As the funds’ performance has surged, investors have poured in.
Net new cash invested in foreign stock funds accounted for about 85% of the total inflow to all stock funds from January through May, according to the Investment Company Institute.
Does that make foreign stocks the tech issues of this era?
The upbeat view of the foreign-investing wave is that people finally are globally diversifying their portfolios, which could be crucial to their long-term success. In this case, I say: Better late than never.
But it’s also likely that performance chasing is a major driver in the popularity of foreign-stock funds over domestic funds, said Russ Kinnel, director of fund analysis at Morningstar Inc. in Chicago.
There’s a danger, he notes, that investors who’ve become enamored of foreign funds in this fat period don’t fully appreciate how volatile they can be over time.
Yet even in the continuing rush to foreign funds, there are signs of investor caution, Kinnel says. “The good news is, they’re picking really well,” he says of investors’ top choices among foreign funds. Large, well-diversified, low-cost funds dominate the list of the most popular foreign portfolios.
The top-selling foreign fund this year is the Dodge & Cox International fund, Financial Research data show. Although the fund is just 6 years old, San Francisco-based Dodge & Cox has been managing money for 77 years and has a reputation as a savvy, value-oriented stock picker.
Another sign that investors are conscious of risk in foreign funds: Net cash inflows to emerging-market funds have dropped sharply this year, to $4.8 billion in the first five months, down 45% from the year-earlier period, Financial Research said.
All in all, it could be that individual investors are showing what would amount to remarkable prescience. If the global bull market is nearing a peak, people who have been avoiding stocks will feel smart, or lucky, or both.
But there’s also a chance that investors’ caution with mutual funds is a sign that the market hasn’t yet entered the phase of frenzied buying that typically marks a top.
And for people who have mostly been sitting on the sidelines of the stock market for almost half a decade, this reminder shines brightly: You can play it too safe.
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Biggest exchange-traded funds
Here are the 20 largest exchange-traded funds, by assets, ranked by their second-quarter performance. ETFs, which trade like stocks, track indexes of stock and bond market sectors.
*--* Total return Fund Ticker 2nd-q. YTD 3-yr.* iShares FTSE/Xinhua China 25 FXI 25.8% 15.6% NA Index Energy Select Sector SPDR XLE 14.8 18.4 31.6% iShares MSCI Emerging Markets EEM 13.0 15.1 36.4 Index PowerShares QQQ QQQQ 9.4 10.5 8.6 Diamonds Trust, Series 1 DIA 9.1 8.9 11.3 iShares Russell 1000 Growth Index IWF 6.7 8.1 8.5 SPDRs SPY 6.4 7.1 11.6 iShares S&P; 500 Index IVV 6.2 6.6 11.6 Vanguard Total Stock Market ETF VTI 6.0 7.4 12.6 iShares MSCI EAFE Index EFA 5.9 10.3 21.4 iShares S&P; MidCap 400 Index IJH 5.8 12.2 15.0 MidCap SPDRs MDY 5.7 12.1 14.8 iShares S&P; SmallCap 600 Index IJR 5.1 8.3 14.2 iShares Russell 1000 Value Index IWD 4.9 6.0 15.7 iShares Russell 2000 Index IWM 4.5 6.7 13.3 iShares Dow Jones Select DVY 1.4 3.3 12.4 Dividend Index iShares Lehman 1-3 Year Treasury SHY 0.7 2.1 2.9 Bond iShares MSCI Japan Index EWJ -0.4 2.1 11.5 iShares Lehman Aggregate Bond AGG -0.7 0.6 3.7 streetTRACKS Gold Shares GLD -2.2 2.2 NA
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*Three-year returns are annualized.
Returns are based on changes in market value, plus dividends.
Source: Morningstar
