Wall Street's Sheep Flock to Fund-Redemption Fodder

The perennial rumors of vast redemptions from mutual funds are making the rounds, but as usual they appear to be off-target.

Wall Street insiders take it as a given that the 88 million folks who own mutual fund shares will yank their money whenever there's trouble, sending stocks plunging. In fact, fund holders often shoulder much of the blame whenever the market does fall; the fear of redemptions wields considerable power as a result. In the wake of Tuesday's terrorist attack on Manhattan's financial district and the Pentagon, the whispers are circulating once again.

But this convenient story ignores the fact that in the past, most fund investors have stood their ground when political events rocked the markets. And they seem to be doing the same in the face of Tuesday's tragic events, judging from a survey of fund companies and a look at activity in money market funds, many of which have been available for purchases or redemptions for the past two days.

"We've called a number of the big fund families, including Fidelity, T. Rowe Price and Vanguard, and thus far there has been no evidence at all that there will be mass redemptions of mutual funds," says Scott Cooley, a senior fund analyst at Chicago fund tracker Morningstar. "In fact, several of the places we talked with said they'd had positive orders, on balance. I just don't think we'll see big sales."

The bottom line: If there's a crippling wave of selling in the markets on Monday, don't assume it's due to an ocean of rattled fund investors.

Whites of Their Eyes

It bears noting that fund investors are a significant presence in the stock market, but they are far from a dominating force. Since funds' stock positions represent about 20% of the U.S. market's capitalization, short-term flows into or out of stock funds typically have little impact on the market.

And fund investors' record in holding their fire is much better than the conventional wisdom would have you think. In 1998, for instance, when Russia defaulted on obligations and the S&P 500 fell 10% in the third quarter, more than 80% of fund investors held on to all their shares. Whether you call it buy-and-hold investing or just plain inertia, staying the course is a hallmark of fund investing. In each of 1991, 1995, 1997 and 1998, fewer than a third of fund investors redeemed shares, according to surveys by the Investment Company Institute, the fund industry's largest trade group.

Light redemptions from the battered Janus family of funds this year illustrates this point as well. Many of the Denver firm's funds rode outsize bets on tech stocks to steep gains in 1999 and raked in cash last year. Over the past year tech-stuffed funds like (JAVLX)Janus Twenty, (JAVTX)Janus Venture and (JAGTX)Janus Global Technology have lost more than half their value. In light of these losses and the closure of several funds, observers expected crippling outflows -- but they haven't materialized. Yes, redemptions have outpaced investments from Janus' retail funds by $5.9 billion, but that's less than 5% of those funds' assets, according to Financial Research Corp., a Boston fund consultancy.

Why are fund shareholders so resilient? More than 60% of U.S. households that own funds own them at least in part through tax-deferred retirement accounts like 401(k)s and individual retirement accounts. Because this money typically stays in the account until an investor retires, there's little urgency when things go wrong in the near term. As we've noted, sudden short-term losses in reaction to strife tend to smooth out pretty quickly.

Also, most investors buy their fund shares through an adviser who can help them see the value of sticking with their portfolio in a tough market, rather than timing their moves, which turns out to be a good way to run up a big tax bill or whittle returns -- not make money. In 1999 more than 80% of fund shareholders bought their shares either through their employer's tax-deferred retirement plan or through an adviser.

Holding Up Their End

Even firms that primarily sell directly to investors working without an adviser are reporting little panic so far.

"We have talked with thousands of clients -- from individual investors to large institutions -- since Tuesday morning," Vanguard Chairman John Brennan said in a statement on the company's Web site. "I'm pleased to say they have demonstrated patience, understanding and a common-sense focus on the long term."

Even if redemptions from stock funds are steep next week, it won't necessarily cripple the market. Most fund companies have lines of credit with banks so they can cash out investors without selling gobs of stock. Many funds can also borrow cash from one another if they need it in the short term.

If you do need money today, it's best to tap any money you might have in a money market account first. Most firms have allowed investors to buy or sell shares of these funds for the past two days, reporting no operational problems.

In any case, think long and hard before you sell shares of a stock fund. Because the market is closed, your fund shares will be priced at the end of the next trading day. Given the tragic events we've witnessed and the long trading layoff, that price could be pretty low -- so for most investors it makes sense to hang in there.

Then again, given fund investors' reluctance to trade, that's probably been their plan all along.

>To order reprints of this article, click here: Reprints