Posted on: Sunday, December 14, 2003
Funds remain popular despite scandal
By Russ Wiles
Arizona Republic
Investors have had ample reason to turn their backs on stock mutual funds over the past three months.
Since New York's attorney general leveled the first claims of illicit late trading and market timing in early September, it seems that each week has brought new, worrisome headlines of companies fined, executives forced to quit or traders censured.
A Reuters article wondered, "How much worse will it get?" A New York Times column all but predicted a "stampede" of investors out of funds.
Yet most people seem to be taking the investigations in stride. In fact, stock funds appear to be more popular today than when the scandal broke.
The Investment Company Institute just reported a $26 billion net cash inflow to stock funds in October, the best showing this year, after a $17 billion inflow in September. November figures won't be released until late December, but no signs of a stampede are evident.
In a recent Gallup Poll, 67 percent of fund investors said investigations into fraudulent practices won't affect their decisions to buy mutual funds.
It's possible the dust has yet to settle, especially if regulators throw their nets around more big-name fund groups.
Mutual funds needed decades to attract their current $7.2 trillion total, which includes $3.4 trillion in stock funds, where the alleged abuses are centered. It could take time for disgruntled shareholders to find new homes for their money.
But indications are a mass exodus won't happen for the following reasons:
• The stock market is rising as the economy improves. Prices are up modestly since Labor Day and sharply for the year. As long as people see their funds gaining, they'll be reluctant to cash in their chips.
• Investors can't tell how much they've been harmed because the damages haven't been quantified. Besides, the implicated fund groups have promised to make shareholders whole through restitution.
• Back-end surrender charges imposed by many funds may be keeping some people from exiting, while tax considerations could be giving others reason for pause.
• Not many rival investments are close substitutes for mutual funds. Exchange-traded funds are pretty close, but they lack lengthy track records and aren't well known by the public. Because you pay a commission for each trade, ETFs don't work well for people investing small amounts on a regular basis.
You could make a case for buying individual stocks or gravitating toward privately managed stock accounts, but these areas also have seen their share of fraud.
• Perhaps more than anything, investor inertia is a key force. When the news turns sour, people tend to hold off on buying rather than bail out. In 2002, the toughest market climate in a generation and a year with ample Wall Street scandals, equity funds suffered cash outflows of just 1 percent. Similar patterns have characterized previous bear markets.
It thus appears investor reaction to the scandal will more closely resemble a game of musical chairs than a stampede. Many shareholders may switch their money from one fund group to the next but ultimately will stay in the room.
