Success of Mutual Funds Is in Eye of the Shareholder

U.S. stock mutual funds in 2000 took in $309 billion in net new cash from investors, by far the industry’s biggest-ever inflow.

But whether the year was a success for the fund business--and for the investors whose money the funds manage--may be a matter of individual interpretation.

Consider: More than half the new cash that stock funds attracted flowed in between January and April, just as the equity market peaked, then dived. Many of those fund buyers remain underwater.

Meanwhile, Treasury and municipal bond funds racked up healthy returns for the year. Yet investors, on balance, pulled money out of bond funds in 2000, according to year-end data reported Tuesday by the Investment Company Institute, the fund industry’s main trade group.

It also was a year when a new rival to traditional mutual funds blossomed: Exchange-traded funds, an easy way for investors to own broad or narrow swaths of the market, saw assets double to $70 billion.

“Telling the fund industry they had a great year is like telling Chrysler that 2000 was a great year for car sales,� said Russel Kinnel, director of research at fund tracker Morningstar Inc. in Chicago. “The reality is the environment is much more challenging than the year-end totals show.�

Still, some analysts say the $7-trillion-asset mutual fund business, which two years ago was viewed as having crested, may have burnished its image with investors in key ways last year. For one, the stock market slide that started with last spring’s bursting of the tech bubble may have reinforced the value of diversified and professionally managed equity funds versus investing in individual stocks.

“Mutual funds were presented as boring, expensive and tax-inefficient, and yet more than $300 billion came in,� said Avi Nachmany, analyst at Strategic Insight, a New York-based consulting firm.

Indeed, despite the stock market’s struggle last year, stock funds’ net cash flows (new purchases minus redemptions) stayed positive every month, the investment institute’s data show. And this month, as Wall Street has resurged, an estimated $21 billion in new money has flowed into equity funds, according to research firm TrimTabs.com.

Here’s a look at some of the major fund industry trends of 2000:

* The big got bigger. Janus Funds took in an estimated $37 billion in net new cash last year, making it the top-drawing firm, according to Boston-based Financial Research Corp. Janus held on to the No. 1 spot despite a $2.1-billion net cash outflow in the final quarter as its tech-heavy funds plummeted.

Vanguard Group had the second-largest net cash inflow, at $22.2 billion, Financial Research said. No. 8 Fidelity Investments and No. 9 PIMCO took in $7.9 billion and $7.7 billion, respectively.

Many of the giants continue to benefit from the constant stream of money flowing to funds via 401(k)s and other retirement savings plans.

But in a testament to how tough the year was on many smaller fund firms, 55% of the nearly 600 fund companies that Financial Research tracks had net outflows in 2000 in their stock and bond funds combined.

* Bond funds continued to lose allure. Investors cashed out of bond funds at the highest rate since 1994 despite strong returns in such bond categories as Treasury and municipal funds.

Helped by falling interest rates that boosted the value of older bonds, the average bond fund posted a total return of 7.7% last year, according to fund tracker Weiss Ratings. The average diversified U.S. stock fund, by contrast, fell about 2% for the year.

Yet taxable and muni bond funds had net cash outflows of $34 billion and $14.5 billion for the year, respectively, the investment institute said.

A chunk of the outflow was attributable to corporate junk bond funds, whose values tumbled on worries about the economy’s health. So far this month, bond fund inflows overall are topping $2 billion, TrimTabs.com estimates, as investors react to Federal Reserve interest rate cuts.

Still, “bond funds aren’t the stuff that [investors’] dreams are made of,� said Carl Wittnebert, research director at TrimTabs.com.

Investors who want income from their funds may be happy to simply stick with safe money-market funds, which took in $160 billion in net new cash last year, the investment institute’s data show.

Another factor could be that investors, especially those using financial advisors, are buying individual bonds rather than fixed-income funds, experts say.

“Clients who want bond exposure are concerned about safety. With carefully chosen corporate or municipal bonds, you know you’re getting at least your principal back at maturity, but with a fund there’s no guarantee the [share] value won’t fall,� said Newport Beach financial planner Laura Tarbox.

* Competition from ETFs intensified. Exchange-traded funds, or ETFs, mushroomed in number during the last year to nearly 100.

ETFs have been marketed by Wall Street firms in part as an answer to some of the drawbacks of the conventional mutual fund structure. ETFs, which typically track a basket of stocks such as key market indexes, tend to be tax-efficient (in other words, they don’t pay out large annual capital gains), and they trade like individual equities rather than pricing once a day as most conventional funds do.

ETF assets reached $70.8 billion at the end of 2000, double the year-earlier total, Strategic Insight said.

This year, brokerages are cranking up the competition by rolling out bond ETFs and, perhaps by this fall, actively managed ETFs.

Still, the conventional mutual fund--whose numbers totaled 8,184 at the end of 2000, up from 7,791 at the end of 1999--clearly isn’t in danger of going out of style.

Though cash flows to equity funds waned late in 2000, they stayed positive even as online brokerages suffered sharp declines in trading of individual stocks.

What’s more, the bulk of actively managed, diversified U.S. stock funds beat the Standard & Poor’s 500 index in 2000 for the first time in seven years.

Tarbox said that early last year people would recite the mantra, “Just buy the QQQ,� referring to the ETF that tracks the tech-heavy Nasdaq 100 index. “Now they are asking us, ‘Why aren’t we doing more mutual funds?’ �

Overall, mutual fund assets rose just 1.8% last year to $6.97 trillion. The industry, at these asset levels, almost certainly will be growing more slowly than in the early 1990s, experts say. But although the days of hyper-growth may be over, analysts still say the fund business is a decent growth industry.

“If overall assets rise a modest 10% a year--say, 5% from performance and 5% from new investments--in 10 years this could easily be an $18-trillion to $19-trillion business,� said Geoff Bobroff, an industry consultant in East Greenwich, R.I. “That’s still quite healthy.�

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Bond Funds’ Allure Fades

Bond mutual funds, including Treasury, municipal and corporate funds, suffered a net cash outflow of $48.5 billion in 2000, the worst since 1994. Bond fund assets have declined in recent years, even as the total amount of bonds outstanding worldwide has mushroomed.

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Money Flows Out . . .

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Net cash inflow or outflow, in billions

2000: -$48.5 billion

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. . . And Total Assets Decline

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Year-end assets, in billions

2000: $809 billion

Source: Investment Company Institute

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Stock Funds: Big Year but Front-Loaded

U.S. stock mutual funds took in a record $309.3 billion in net new cash in 2000. But more than half the money flowed in during the first four months of the year, as the market peaked, then began to slide.

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The Funds Saw Record Inflows . . .

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Net new cash flow to stock funds each year:

2000: $309.3 billion

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. . . But Many Buyers Caught the Market Peak

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Net new cash flow to stock funds each month in 2000:

December: $11.6 billion

Source: Investment Company Institute