July's Tech Crunch Squeezes More Dough Out of Stock Funds

Battered fund investors are seeing the stock market as more money pit than cash machine these days.

That's the upshot from a report on July cash flows to mutual funds, released Monday by fund-tracker Lipper. Redemptions from stock funds, which on average lost 3.2% of their value last month, outpaced investments by about $1.5 billion. At the same time, $15.3 billion gushed into the safer havens of bond and money market funds, pushing the average bond fund up 1.7% for the month.

These figures are just the latest illustration of fund investors' growing distaste for stock funds, many of which have foundered during the stock market's ongoing, tech-led collapse. It's not clear whether fund investors are leaning toward bond funds to sensibly balance out their portfolios, or whether they are simply following the familiar and often destructive impulse to buy shares of whatever funds are performing best at any given time. What is clear is that they've lost the loving feeling they had for stock funds just a year ago.

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Investors stuffed a record $309 billion into stock funds in 2000, mostly in tech and tech-heavy growth funds. They were no doubt emboldened by 1999's heady gains, when the average tech-sector fund gained a stunning 136%, according to fund-tracker Morningstar. But with the average tech and large-cap growth funds down 62% and 38%, respectively, over the past 12 months, fund investors' stock-fund enthusiasm has been on the ebb.

Consider that in the first six months of 2000, stock funds took in more than $215 billion, compared with just $47.5 billion over the same stretch this year. Thanks mainly to institutional investors, money market funds took in a whopping $176 billion in the first half of this year. At the same time, taxable bond funds and tax-free municipal bond funds have gobbled up more than $35 billion cumulatively, compared with combined outflows of about $40 billion in the first half of last year.

No Thanks Investors' slimming appetite for stock funds ($billions)
	2001	2000
Money Market Funds	$175.8	$12.7
Stock Funds	47.5	215.1
Taxable Bond Funds	30.8	-25.9
Municipal Bond Funds	5.3	-14.4
Source: Investment Company Institute. Data through June 30.

Cash flows to mutual funds are closely watched as a barometer of investor sentiment, but some observers contend they can help predict returns. An optimist, for example, might argue that rising cash flows to funds point to better stock returns because fund managers putting that money to work could boost share prices.

That said, even last year's record flows into stock funds didn't keep the S&P 500 or the tech-laden Nasdaq Composite from falling 9% and 39%, respectively. That's why, in the often-confusing world of Wall Street, pessimists assert that strong inflows often point to a near-term high.

If there's any constant in fund flows, it's that at least some fund investors won't buy shares of a stock fund unless stocks have posted decent returns recently. That reflex has been particularly apparent this year. Aside from May, each month's cash flows to stock funds have risen and fallen in lock step with the Nasdaq Composite.

Chasing Returns As usual, cash and returns have moved in lock step
Month	Stock-Fund Cash Flows ($billions)	Nasdaq Composite Return
January	$24.6	12.2%
February	-3.1	-24.2
March	-20.6	-16.6
April	25.0	15.0
May	5.8	-0.3
June	13.0	2.4
July	-1.5	-4.5
Source: Lipper, the Investment Company Institute and Baseline/Thomson Financial.

That's not to say that all stock funds are in net redemptions. Money is predictably flowing into categories with the best recent performance. In general tech-light value funds, whose bargain-hunting ways kept them out of that mercurial sector, have outpaced their tech-sick growth peers so far this year. Consequently, their cash flows are in the black, while growth funds continue to see outflows.

Value's Time Money is flowing into better-performing value funds
Fund Category	YTD Return	July Cash Flow ($billions)
Large-Cap Value	-3.8%	$0.5
Large-Cap Growth	-23.1	-2.5
Mid-Cap Value	3.3	2.3
Mid-Cap Growth	-22.4	-1.3
Small-Cap Value	12.6	1.9
Small-Cap Growth	-12.0	0.3
Source: Morningstar and Lipper.

The bottom line is that fund investors' sagging interest in stock funds, and their growing appetite for bond and money market funds, is as understandable as it is pronounced. Still, we should all remember the tired but true saw that for 99% of fund investors, it makes sense to build a diversified portfolio that includes stock, bond and money market funds, rather than chasing today's leading sector or style.

If you're looking for some detail on that, we've shown you how to build a diversified portfolio with some worthy candidates, and we have noted the fat gains earned by folks who hold on to diversified portfolios through blue periods like this one.