The Death of Equities May Be Exaggerated

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Aug. 31, 2010, 2:33 p.m. EDT · Recommend (1) · Post:

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By Sam Mamudi, MarketWatch

NEW YORK (MarketWatch) -- Reports of investors fleeing the stock market may have been overstated.

In fact, rather than leaving stocks behind, evidence suggests that investors are ditching U.S. stock mutual-fund managers and putting money into index funds that track established U.S. stock benchmarks as well as international stock funds.

Flows into U.S. stock index mutual funds and international stock mutual funds outpace flows heading out of actively managed stock funds so far this year, according to research firm Lipper.

It's been a bruising month for stocks, with both the Dow and S&P 500 on pace to post their worst August since 2001 and the Russell 2000 set to see its weakest August in 12 years. There's not a lot of bright lights on the horizon for September either.

Moreover, by one measure this trend has been going on for years. Since the end of 2005, actively run U.S. stock funds have seen net outflows every year, totaling $369 billion, while indexed counterparts -- not including exchange-traded funds -- have seen net inflows of $112 billion, according to fund-industry trade group the Investment Company Institute.

Of course, over the same period bond funds have been reaping record inflows. But the numbers show that some investors are still investing in stock mutual funds -- but have given up trying to beat the market, deciding instead to use cheaper index funds.

The difference between the exodus from actively managed funds and net flows into indexed funds has narrowed slightly this year, but still paints a clear picture of investor sentiment. See related story on the 'death of equities.'

And the market's choppy performance so far this year, with the Standard & Poor's 500-stock index /quotes/comstock/21z!i1:in\x (SPX 1,046, -3.20, -0.31%) down more than 4% in August alone, may not lure buyers back into actively managed funds for a while at least. Read Tuesday's Market Snapshot.

"People have decided, given the uncertainty, that they'd rather make a broad bet [rather than rely on a manager to choose a small number of stocks] in the hope that a rising tide will lift all boats," said Tom Roseen, senior analyst at research firm Lipper Inc.

MarketWatch asked Lipper and ICI and to break out their U.S.-focused stock fund data to look at flows for the two types of funds. ICI's numbers show that through the end of July, U.S. actively managed mutual funds saw net outflows of $45 billion this year, but over the same period, index-linked U.S. mutual funds saw net inflows of $14.4 billion.

ICI's numbers include flows into variable annuities. But Lipper figures strip out variable annuity flows, leaving only flows directly into mutual funds from investors or their financial advisers, which perhaps better reflect broad investor outlook.

Those numbers show that through the end of July, domestic index-linked mutual funds saw net inflows of $28.8 billion compared to net outflows of $29.5 billion for actively run mutual funds.

International-fund activity also suggests that investors are consciously shunning domestic stock fund managers. Actively run international-focused stock funds saw net inflows of more than $19 billion this year through July, according to both ICI and Lipper. Indexed international funds, meanwhile, took in almost $8 billion, according to both groups. In other words, investors aren't ignoring active management altogether.

The numbers pale by comparison to bond funds, which are seeing spectacular net inflows -- more than $180 billion this year through July 31, according to ICI. But they do belie the notion that investors are fleeing the stock market.

Though investors' embrace of index funds is clear, it may not reflect a long-term shift away from actively managed U.S. stock funds. Roseen said some of the movement may simply be reallocations by investors -- after all, active U.S. stock-fund managers still handle around $3 trillion in assets.

"Active funds still have the majority of assets -- people might just be reallocating some dollars to index funds, or changing their broader asset allocation altogether," said Roseen.

But investors may also be wising up to the fact that for most of them, indexed funds are a strong option. Not only have studies repeatedly shown the majority of actively managed funds lag their indexes, but lower fees also benefit investors.

Total fees for the average traditional U.S. index fund -- excluding derivatives-driven index funds -- are 0.54%, compared to 1.41% for the average actively managed U.S. stock fund, according to Morningstar.

A study earlier this month by Morningstar found that low fees are the best predictor of a fund's future success, trumping even the fund researcher's star-rating system. If nothing else, lower fees give an investor a head start in the quest for positive returns.

Said Roseen: "Even if your index fund is charging 0.5% less [than actively-managed funds], that's going to add up over the long run."

Sam Mamudi is a reporter for MarketWatch, based in New York.

Back to school: a time of reinvention in the crisp autumn air. Then there's the fresh notebooks and new clothes -- at least that's what retailers are hoping for.

12:56 p.m. Today12:56 p.m. Aug. 31, 2010 | Comments: 4

I switched to equity index funds about 10 years ago after a couple of decades of chasing the "hot hand." I eventually realized no one has one. My performance has been with the markets. Rebalancing helped minimize the downdrafts and I'm well ahead of where I was in 2000. I buy individual bonds and CDs because I want to know that in some point in time I'll get all my principle back..."

- 2B | 3 min ago1:49 p.m. Aug. 31, 2010

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