September Selloff Puts Stock Funds in Redemption Land

Stock funds, which took in $309 billion last year, have now seen net redemptions for 2001.
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Fund investors didn't panic last week, but they're still far from smitten with stocks.

Redemptions from stock funds outpaced investments by $11 billion in the week ended last Thursday, while retail money market funds took in a net $8 billion, according to the latest estimates from liquidity tracker TrimTabs.com. Yes, $11 billion is a lot of money, but it adds up to just 0.3% of the $3.5 trillion invested in stock funds, according to the Investment Company Institute, the fund industry's largest trade group. The record for redemptions over a five-day stretch is $15.3 billion, set in the week ended March 21.

But don't break out the bubbly yet, because the longer-term cash flow figures are far from rosy. Last week was the fourth consecutive week of net outflows from stock funds by TrimTabs' count, as the Sept. 11 terrorist attacks hastened already-battered stocks' plunge. And since Jan. 1, stock funds are actually in net redemptions, thanks more to sagging sales than heavy redemptions by TrimTabs' count. Data from rival outfit Lipper estimate a $52 billion net inflow for stock funds through Aug. 31; flow figures often differ until final numbers are published each month by the ICI. Still, Lipper's figures also indicate higher cash flows to bond funds than stock portfolios.

The upshot: No matter which estimates you choose, it seems the potent combination of last year's record $309 billion in stock-fund sales and the past 18 months' losses have shaken fund investors' confidence in equities, sending them to the safer havens of bond and money market funds.

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This marks a tectonic shift from last year, when 1999's tech-led gains made stocks seem like a less risky, or even riskless, place to put your money. Consider that at this time last year, stock funds had netted more than $260 billion, compared to $5.2 billion in net redemptions over the same stretch this year, according to TrimTabs.

While Lipper's data aren't as stark, they also illustrate a shrinking appetite for stock funds. Last August stock funds netted $22 billion, for instance, compared to an $8 billion outflow last month.

Less risky bond and balanced funds have also witnessed a reversal of fortune. At this point last year they averaged weekly outflows of $1.5 billion, but this year they're taking in $1.4 billion each week, on average. Through the end of August they'd netted some $54 billion, compared to $53 billion in outflows in the same period last year.

Cash flows to mutual funds are closely watched as a barometer of investor sentiment, but some pundits use them to argue for good or bad times ahead. An optimist, for instance, might argue that rising cash flows to funds are positive for the market because fund managers putting that money to work could boost share prices.

Then again, even last year's record $309 billion inflow to stock funds didn't keep the

S&P 500

and the

Nasdaq Composite

from falling 9% and 39%, respectively. Consequently, in the often perplexing world of Wall Street, pessimists can make the case that high inflows point to a near-term high.

If there's any constant, it's that at least some fund investors won't buy shares of a stock fund until they think they have a reasonable chance to earn money in the short term. While the reflex is understandable, waiting to invest until you're brimming with confidence -- rather than investing a set amount each month -- can be costly because it typically ensures you're buying high and selling low, not vice versa.

Investor cash flows, as usual, appear to be driven by returns. Thin-air valuations paired with a sagging economy and sharp reduction in corporate spending on technology have walloped stocks since the Nasdaq Composite's peak last year. The average bond fund is beating the S&P 500 by some 38 percentage points over the past year. Bond funds are also topping stocks over the past three years. While some might rightly argue that this augurs for a commitment to stocks, since they've historically outperformed bonds, it seems many investors aren't willing to make that bet.

With fund firms poised to mail out mostly dreary Sept. 30 account statements next week, it's hard to imagine Main Street investors will be getting more excited to send checks to Wall Street. Consider that a $10,000 investment in the vanilla

(VFINX) - Get Report

Vanguard 500 Index fund, which tracks the S&P 500, would've been worth less than $8,000 on Aug. 31 -- before the Sept. 11 terrorist attacks rattled investors and sent already battered stock prices even lower. The same investment in top-selling bond fund

(PTRAX) - Get Report

Pimco Total Return would be worth nearly $12,000, according to Morningstar.

The bottom line is that until fund investors see sustained gains from stocks and stock funds, many will stay on the sidelines.

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.