A Nightmare on Main Street as Funds Fail

BOSTON ( TheStreet) -- The mutual fund industry this year has been overrun by a stampede out of U.S. stocks and into safer alternatives, namely large-company and bond funds, much as in 2008 when the financial industry needed a bailout to survive.

Investors pulled $14.6 billion from U.S. equity mutual funds and put $102 billion into taxable bond funds through the end of July, said Ryan Leggio, a mutual fund analyst at Morningstar. The S&P 500 Index is down 6.6% so far in 2011 after two years of gains and a slight rebound last week. The benchmark for American equities lost 16% of its value between July 22 and Aug. 19, the most in four weeks since March 2009, which turned out to be the bottom of the most recent stock-market crash.

"It's been a flight to bonds and away from equities," Leggio said.

U.S. Treasuries, considered the safest investments in the world, have rallied, pushing down yields to a record low of 2.2% from 3.4% at the beginning of the year. So-called long bonds are the best-performing category, with a gain of 17%, followed by the inflation-protected bonds, at 9.1%.

In the volatile week that just ended, long-term mutual funds had estimated outflows of $772 million, according to the Investment Company Institute, a trade group. That's because of investors' concerns about the creaky global economy, outsized U.S. debt and the euro-zone's sovereign debt crisis.

Since the end of June, all 10 sectors of the S&P 500 are down, with utilities the least, at 1.9%, followed by consumer staples, minus 4.3%.

Earlier this year, gold-mining fund managers had the hot hand, and then it was health-care funds, but now its rock-ribbed conservative investment choices that pay dividends and have a reliable, virtually impenetrable customer base.

"We've seen pressure on stocks due to macroeconomic concerns, so it's made it a challenge for any portfolio manager to gain ground," said Todd Rosenbluth, Standard & Poor's mutual fund industry analyst. "The ones that have done well have been in more defensive sectors, such as health care and utilities."

Particularly telling of the market's turn, only two U.S. stock funds are in positive territory in the past three months, the $13 million currency fund Midas Perpetual Portfolio ( MPERX), with a 3.1% gain, and the World Commodity Fund ( WCOMX), at 1.2%. The latter invests in natural resources and has assets of $1.4 million. The Cook & Bynum Fund ( COBYX) is dead even for the period.

But other than those performances, all others are in the red, and about half of the list of top-performing U.S. stock funds have the word "utility" in their title.

Funds with big exposure to telecommunications and utilities stocks have done relatively well. Those shares have more defensive characteristics in that they have high yields and steady sources of revenue so they provide downside protection, Rosenbluth said. "Investors are looking for stability and income," he said.

One of the better performers is the Franklin Utilities Fund ( FKUTX), which has lost only 2.2% since June but is up 7% for the year. Holdings include Sempra Energy ( SRE), one of the most diverse natural-gas plays in the country.

Another top holding is NextEra Energy ( NEE), a regulated Florida utility that should benefit from long-term demand growth in the state, while its business has expanded into wind generation and now solar power, which bodes well for its future.

Some funds that are holding up well are diversified in the health-care sector. For example, the Hussman Strategic Growth Fund ( HSGFX) is up 3.6% since the end of June and got great returns from two health-care stocks, Humana ( HUM), up 30% this year, and AstraZenaca ( AZN), up 3%.

The biggest winner so far this year among mutual funds is the ProFunds UltraShort Emerging Market Fund ( UVPIX). The $6 million "bear market" fund has jumped 27% by making bets on currencies.

Among U.S. stocks funds, the Pimco Real Estate Real Return Strategy Fund ( PETAX) has risen 13%. The $1.4 billion fund invests in credit derivatives.

Hussman Strategic Total Return ( HSTRX), with $2.4 billion in assets, is also performing well with a 4.5% return.

"Portfolio manager John Hussman uses various assessments of valuation and other market signals to tactically manage this fund's allocation to bonds (mainly U.S. government securities) and other investments (such as currency exchange traded funds, and energy and precious-metals stocks)," Morningstar says.

Even bellwether funds are challenged by this investing environment. Take Will Danoff, for example. His $78 billion Fidelity Contrafund ( FCNTX) has fallen 5.6% this year, including 12% in the past month. But over the past 12 months, the fund has gained 14%.

About 31% of Contrafund is in technology, led by the maker of the iPad and iPhone, Apple ( AAPL), at 6.8% of assets.

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