Unlike Soros, Public Hasn’t Had Its Fill of Risk

For much of the late 1990s, the U.S. economy and many of its investors were on the receiving end of a spectacular wealth transfer.

The Mexican peso’s collapse, the Asian financial crisis, the plunge in oil prices, the Russian debt default and other global shocks were terrible news for the economies in which they were centered.

But for America, the net effect was a strong dollar, lower inflation, cheaper imports, subdued interest rates and higher stock prices.

Others’ losses were our gains. There’s your wealth transfer.

During the last 12 months or so, Wall Street has been the venue for a different kind of transference. This one is a risk transfer within the $13.5-trillion U.S. stock market.

The central element of this shift has been the willingness of individual investors to take on substantially greater risks in their personal portfolios, at the same time that many market professionals have been seeking to lower their risk profiles--the latest in the latter category being George Soros, the legendary hedge fund manager who on Friday announced a broad retrenchment of his speculative activities.

Small investors’ appetite for risk has been most evident, of course, in their purchases of technology stocks and aggressive mutual funds that loaded up on those stocks.

On the other side of that equation have been tech company insiders, who have cashed in mountains of personal stock at hefty prices; venture capitalists, who have unloaded their stakes in young tech companies well before the businesses had any shot at profitability; and investment bankers, who are only too happy to feed investors whatever it is they think they want, regardless of the investment merit.

With the tech-stock sector’s dive since early March, the widespread assumption on Wall Street was that this massive risk-transference would grind to a halt. Saddled with instant and severe losses in high-risk stocks, the public would not only balk at buying more, but would probably dump much of what it owned in a blanket admission of investment error, many pros feared.

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Yet as the stock market’s miserable April comes to a close, there are few signs that small investors are rushing en masse to lower the risk level of their portfolios--despite a net 15.6% drop in the Nasdaq composite stock index for the month.

Instead, the evidence suggests that many individual investors have held on tight to their tech stocks and aggressive mutual funds. What’s more, other individuals who may have sat out the run-up in “new-economy� stocks in the first quarter appear to be stepping up to buy now that prices are lower--even if, by historical yardsticks, these shares arguably are still overvalued.

Last week, major mutual fund companies reported some surprising numbers regarding their March and April cash inflows. On balance, investors were buying less of the tech-stock and aggressive-growth funds that enjoyed unprecedented demand in January and February. But even with the heavy losses in those high-risk funds since mid-March, many of the funds had net cash inflows even for April.

Janus Capital, the Denver-based fund giant that has become a symbol of high-risk, high-return investing in the last few years, said it took in a net $3 billion in new money in April. That was about one-third its recent monthly peak inflows. But considering that the market headlines in the first few weeks of April were primarily about the supposed demise of the tech-stock boom, $3 billion represents a stunning vote of confidence on the public’s part.

Likewise, T. Rowe Price Associates in Baltimore said its giant Science & Technology stock fund took in a net $300 million in new cash in April, and that the fund saw only a few days of net redemptions by investors even during the worst of the tech-stock meltdown.

Now, contrast that experience with hedge-fund king George Soros’ announcement Friday that he’s scaling back his investment firm’s risk-taking activities after decades of adeptly playing wild swings in currencies, bond markets and stock markets worldwide.

“Markets have become extremely unstable and historical measures of value . . . no longer apply,� the 69-year-old Soros told clients.

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Another segment of the institutional-investment universe also has been pulling back in recent weeks, even as the public has continued to push money into mutual funds: The number of U.S. companies announcing plans to buy back their own shares has tumbled sharply this year.

Just 48 companies announced buyback plans in April, according to Thomson Financial/Securities Data. That’s about one-third the level of November and December.

For his part, Soros may have had little choice in the matter. His deputies have been primarily running his money for the last decade (as he has focused on philanthropy), and his two top money managers last week decided to resign.

Nonetheless, Soros’ decision to lower his funds’ risk profile--at a time when many small investors have done just the opposite with their portfolios--raises the obvious question: Who knows better--the aging market veteran, or the army of investors who have just gotten into the game in recent years?

Likewise, many investors may well wonder whether stocks at these marked-down prices can constitute bargains, if the issuing companies themselves don’t seem to think so.

These questions are, of course, too simplistic. A 25-year-old investor who just plunked down a few thousand dollars for shares of T. Rowe Price Science & Technology fund almost certainly has a much longer time horizon than does George Soros, and may be investing exactly as George Soros would if he were that age.

What’s more, there are plenty of individual investors whose knowledge of technology and appreciation for the growth potential of specific segments of that industry no doubt far exceed what George Soros knows.

Warren Buffett, another investment legend, always said he didn’t buy shares of tech companies because he couldn’t understand them. Thankfully for the U.S. economy’s sake since the early-1990s, there have been millions of investors who have understood technology and how it would transform the global economy.

Still, even investors who believe technology shares and other new-economy stocks have a brilliant future must concede that the valuations of these stocks (price-to-earnings, price-to-sales, etc.) have been, and in many cases still are, at levels that defy all conventional investing rules.

In other words, if this is where a huge chunk of your money is parked, you must concede that you have taken on significant risk. It may well be that the payoff for taking that risk will be substantial--but you’ve at least got to admit to the first part of the equation.

Is it inherently wrong for so many small investors to be raising their risk profiles, while Soros and others lower theirs? Of course not. It’s only a problem if an investor lacks an appreciation for just how much risk he or she has taken on--or if that investor could not financially recover from losses, temporary or long-lasting, that could easily materialize if his or her bets go bad.

There are many people on Wall Street who believe that the public’s fascination with, and commitment to, new-economy shares and funds won’t survive a sustained downturn in those investments.

If the market’s slump since mid-March is only the beginning of a shakeout that goes on for months, the level of redemptions from aggressive-growth portfolios and other funds is certain to soar, the market’s doubters argue. There have to be limits to what people can handle, psychologically, in terms of investment losses, after all.

But Avi Nachmany, whose firm Strategic Insight in New York has done some very interesting research on the mutual fund industry and individual investors over the last decade, believes that the threat of large-scale fund redemptions, and a general renouncement of risk-taking by the public, is grossly overstated.

For one thing, he says, “Technology is not a fad. Which is why its [popularity] transcends price movements.�

Speaking more broadly of investing and risk-taking by Americans, Nachmany says: “A lot has to happen to destroy the optimism people have about their financial future.�

Declining investment values, even sustained for months, would have to be accompanied by an erosion of confidence in many other aspects of American life to trigger a massive shift out of the stock market by small investors, Nachmany contends.

“It’s not just financial confidence, but political confidence, economic confidence and patriotic confidence� that would have to deteriorate, he argues. “We’d have to become a nation of pessimists. And that is not in the cards.�

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Tom Petruno can be reached by e-mail at [email protected].

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Stocks: Who’s Buying and Who’s Not

U.S. companies have been active buyers of their own shares for most of the last few years, but the number of companies announcing new buybacks has slumped in recent months. Meanwhile, individual investors’ purchases of stocks via mutual funds reached unprecedented levels in the first quarter.

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Corporate Treasurers Step Away . . .

Number of companies announcing stock buybacks:

48

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. . . as Individuals Step Up

Gross purchases of stock mutual funds, in billions:

First quarter: $419 billion

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Sources: Securities Data Co., Investment Company Institute

Note: Annual figures for 1996 to ’99.