Stock Funds Feel New Pain: Net Cash Outflows

Fund investors are yanking money out of their sagging stock funds, lending some credence to the notion that fund outflows could be the knockout punch this battered market doesn't see coming.

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Fund investors withdrew $13.4 billion more from stock funds than they invested in February, while bond funds took in $2.3 billion more than they lost to redemptions, according to a Monday morning report from liquidity tracker TrimTabs.com. It's the first month of net redemptions from stock funds since August 1998, when investors were blindsided by the near-collapse of massive hedge fund Long Term Capital Management. Though stock prices have been falling for a year, cash flows to stock funds were positive until last month.

Whether you see this as good news -- meaning a bottom -- or an ominous sign -- meaning a prelude to more selling -- it's an about-face from a year ago. In February 2000, fund investors stuffed money into stock funds, which took in almost $54 billion that month, according to TrimTabs.com. As we noted on Friday, extensive and continuing outflows from stock funds could lead to even more selling pressure on battered stocks as fund managers sell shares to meet investor redemptions.

A Different Time Last February money gushed into stock funds and out of bond funds. Last month we saw the opposite

Source: TrimTabs.com.

"I think if you look at flows over the last few months, they've been up and down. Normally I tune that out, but you have to think that a strong economy and a bull market are the pillars under the fund industry. What's happened so far isn't so bad, but if things continue like this it could become a real concern," says Russ Kinnel, director of fund analysis at Morningstar.

The news might not be shocking, but it's significant because fund flows are a closely watched barometer of investor sentiment. Like many financial data points, this outflow can give dry powder to both bulls and bears. Optimists, or bulls, can say fleeing fund investors point to a bottom for stock prices and bonny days ahead, while pessimists, or bears, can use this data to say steady outflows from stock funds will keep stock prices down. (For more details on fund flows, check out TheStreet.com's Metrics Page.)

Fund flows are typically driven by fund performance, and this case seems to be no different. It's too early to say that this money is leaving growth and tech funds, but that might be a logical assumption, as they've gotten the lion's share of money in recent years and are tanking with their favorite tech stocks.

Twelve months ago, surging and pricey tech stocks propelled growth and tech-sector funds to stunning one-year returns that topped 100% in many cases. Now many of those funds have lost anywhere from one-third to more than half their value over the past 12 months. The tech-laden Nasdaq Composite Index is down a breathtaking 55.7%, according to Baseline/Thomson Financial.

February: Nasty, Brutish and Short If tech-stock prices keep falling through the floor, it's logical that money will keep gushing from growth and tech funds

Sources: Lipper and Baseline/Thomson Financial. Returns through Feb. 28.

These outflows are part of a continuing pattern where investors are keeping money on the sidelines rather than in stocks. In January a record $140 billion gushed into mutual funds, but the vast majority of that money went to retail and institutional money market funds. So far this year, retail money market funds are averaging $5.4 billion weekly inflows, compared with $1 billion for stock funds, according to TrimTabs.com.

Despite the market's continuing malaise, it appears that fund managers, unlike their shareholders, are modestly raising their interest in stocks at these depressed levels. At the end of January, the average stock fund had 5.45% of its money in cash, but that figure was down to 5.31% at the end of last month, according to the TrimTabs.com report. Over the past 12 months, funds' cash levels peaked in October at 6.2%.

This too might sound like good news to some. After all, if fund managers are the "smart money" and they're buying stocks, this might presage blue skies ahead. Then again, if they're raising their commitment to stocks, and their shareholders dump their fund shares, that adds up to more selling pressure to meet redemptions.