Investors Aren’t Buying It

MarketWatch featured a story titled “Easy does it,” supporting the view that many U.S. mutual fund investors have not participated in this market rally:

Bull market be damned: U.S. mutual fund investors continue to sidestep this stock market.

According to a report released by New York-based Strategic Insight on Thursday morning, investors put $30 billion into stock and bond mutual funds in February. Read the Strategic Insight report.

For the first quarter of 2010, net inflows to stock and bond funds could top $100 billion, a big reversal from the less than $10 billion garnered in the year-ago period.

But where are investors putting money to work, specifically?

It’s all about fixed income products.

Loren Fox, Strategic Insight’s senior research analyst, says that, with money-market funds and deposit accounts continuing to offer near-zero yields, investors are hungry for income alternatives.

In total, they put $24 billion into bond funds in February. Leading the inflows, says Fox, were short- and intermediate-maturity corporate bond funds, with $10 billion in combined net inflows.

Global bond funds captured more than $4 billion in the latest month, he says, while inflation jitters encouraged inflows of $2.5 billion to TIPS funds.

Enthusiasm for bond funds mirrors trends that unfolded last year. Full-year 2009 inflows to bond funds — including traditional mutual funds and ETFs — reached an all-time record of $396 billion.

The massive inflows into bond funds will continue into 2010, says Fox.

“Interest rates will not rise significantly this year,” he says. “So money market funds and bank deposit accounts will continue to be not all that attractive from a yield point of view.”

“There are two trends at work here,” says Fox. “Investors for many years now have been increasing the global diversification of their portfolios. Also, international markets have done better than the U.S. equity markets. So that has emboldened investors to put more money into international funds.”

However, in contrast to bond funds and international equity funds, investors showed little love for the home team.

Flows into diversified U.S. equity funds were negative in February, says Fox, despite the average domestic equity fund delivering a 3.4% total return in the month and nearly 60% return for the prior 12 months.

But, despite this hard rally, a lot of investors seem to think U.S. stocks are a bad bet, given the uncertain path ahead for a fragile economy plagued by ongoing problems in housing, commercial real estate, and the labor market.

“We are not sure when investors will begin putting more money into equity funds,” Fox says. “They haven’t embraced stock funds because they do have lingering concerns about how this recovery will take shape.”

How do financial advisers, who guide most investment decisions, feel about where to put money to work in the investment world?

According to a survey conducted by Charles Schwab in January, financial advisers intend to pull away from fixed income: 16% plan on investing more in bonds versus 25% in July.

But there wasn’t much cheerleading for U.S. stocks, either: 26% say they’ll invest more in large — cap U.S. stocks versus 30% in July.

Separately, and sort of interestingly, ETFs experienced $5 billion of aggregate net inflows during February, a reversal from the net redemptions seen in January. The biggest draws were U.S. equity ETFs like the SPY.

Why would investors withdraw money from U.S.-focused mutual funds, but commit capital to U.S. equity exchange-traded funds?

One reason, says Fox: Investors might be more comfortable slowly tip-toeing back into the market with relatively cheap, passive vehicles.

“They are a bit less risky because they are lower cost than actively managed funds,” he says.

[Emphasis added]

It’s interesting to note that investors withdrew assets from equity mutual funds and deployed them in equity ETFs. I don’t think that the fact that costs are lower has anything to do with it or the claim that they are allegedly less risky.

I think it underscores the general trend that ETFs are the investment of choice much to the chagrin of mutual funds. No trading restrictions, tremendous choices, intra-day trading and high volume with many issues make ETFs a superior tool.

Last not least, let’s not forget the most important reason for using ETFs: They allow us to easily follow the trends in the market place and let us implement an effective sell stop discipline, in case the markets reverse and head south again.

Protection of our investment capital during bear markets still remains a top priority, a view that has served us well during the severe down drafts of 2000 and 2008.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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