Investors' appetite for shares of sagging stock funds is even weaker than we thought.

Other Junk

First-Quarter Roundup: Funds of All Flavors Head South

Redemptions at Janus Soar

Biotech Funds Look Sicker Than Most Health Funds

Questioning the Buy-and-Hold Strategy

No Redemption: Funds Could Crush the Market

Building the Low-Maintenance Portfolio

Preliminary estimates of cash flows to stock funds in February had redemptions outpacing investments by $1 billion or $2 billion, depending on whom you asked. But in reality things were worse. As stock prices continue to fall, taking stock funds with them, net outflows actually topped $3 billion in February, their first month of net outflows in some two years, according to figures released Thursday afternoon by the ICI, or

Investment Company Institute

, the fund industry's largest trade group.

The upshot: Investors are lowering their portfolios' risk by adding either new cash or money yanked out of aggressive stock funds into balanced, bond and money market funds. This illustrates investors' shifting sentiment, but also could be the start of an ominous trend. If money flows out of growth funds for several consecutive months, fund managers selling stock puts more pressure on the funds' already battered sectors of choice, like technology and telecommunications.

Stock funds' $3.1 billion in outflows doesn't seem like much in relation to the some $3.7 trillion sitting in stock funds, according to the ICI. But it is a marked shift. Consider that in January stock funds took in $25.1 billion more than they lost to redemptions.

The about-face is no doubt driven mainly by performance, or a lack thereof -- fund flows follow performance with a lag. After rising to frothy heights and valuations in 1998 and 1999, stocks have come back to earth. Over the past year the tech-laden

Nasdaq Composite

is down about 63% and the

S&P 500

is off more than 24%. Technology funds and big-cap growth funds, which captured the lion's share of fund sales in 1999 and 2000, are down 63% and 37% over past year on average, according to

Morningstar

.

Consequently, investors are warming to less aggressive fare that isn't falling with the Nasdaq. Stock funds' total cash flows for the first two months of this year are about $22 billion, well below the $100.2 billion they had taken in at this time last year. At the same time, cash flows to bond funds and balanced funds that invest in both stocks and bonds have gone from negative to positive.

Money market or cash funds, the safest haven in the fund world, have seen their flows almost triple from this time last year.

Fund flows are closely watched as a broad barometer of investor sentiment and confidence. In the up-is-down world of Wall Street, steep outflows are often seen as a contrarian indicator, pointing to blue skies ahead. But when money consistently flows from one type of stock fund for several months, it can become a market event.

One Year Later . . .
The money flowing into fund categories has changed considerably from the first two months of 2000 to
the first two months of 2001.

Source: Investment Company Institute.

Here's why: When redemptions consistently outpace investments, a fund manager eventually must sell stocks to cash out shareholders -- potentially weighing down the fund's stocks. Over time, this can create a less-than-virtuous cycle, where flagging performance leads to redemptions, which leads to weak performance and further redemptions.

This happened to value funds in 1998 and 1999 when the tech-light, bargain-hunting funds were dusted by tech-stuffed growth funds. Some $80 billion flowed from these funds in those years, according to Boston fund consultancy

Financial Research

, putting pressure on these funds' favored sectors like financials.

As you might imagine, among stock funds money is flowing out of tech-heavy growth funds and into value funds, which have held up better in this downturn. For instance, several Janus funds rode big tech and telecom bets to high returns and record inflows in 1999. Now, with many funds underwater and still closed to new investors, shareholders are voting with their feet. The firm saw net redemptions of $1.8 billion in February, according to Financial Research.

Though they often blanche at the idea that this redemptive trend has affected the market, stock fund managers are taking some action. In recent years the percentage of money they kept in cash had fallen, but now it's on the rise. In February the average stock fund had 5.9% of its money on the sidelines, compared with 4.9% a year earlier. Either fund managers aren't seeing much reason to own stocks right now, or they're raising cash to meet redemptions.

Early estimates of fund flows so far this month aren't encouraging. Stock funds were in net outflows to the tune of $21.6 billion in the first two weeks of this month, according to liquidity tracker

TrimTabs.com

. It's too early to say whether these outflows will rattle the markets, but it's also hard to say that investors won't stop yanking money out of growth funds until their performance picks up.

Fund Junkie runs every Monday, Wednesday and Friday, as well as occasional dispatches. Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

imcdonald@thestreet.com, but he cannot give specific financial advice.