Investors Shifting Away from U.S. Stock Mutual Funds

Despite a strong performance year for the stock market, investors pulled money out of their U.S. stock mutual funds in 2012. According to original reporting by Strategic Insights the final value of assets in U.S. equities was $4,349 billion this is down $90 billion despite the strong market performance.  $26 billion of that decrease occurred in the month of December alone.  Some of that late selling could be for taxes and some of that could be harvesting profits prior to the fiscal cliff, but this was the sixth year in a row that money has moved away from U.S. stock mutual funds and December was the tenth month in a row that withdrawals have exceeded deposits.   In 2011 $82 billion left U.S. stock mutual funds.

Investors appear to be diversifying their portfolios.  While domestic equity funds were down $90 billion, international stock mutual funds increased $23 billion to a total of $1,739 billion.  This followed a 2011 where the international equities market grew by $31 billion.

The big gainer has been the bond funds. Bond mutual funds gained $317 billion in 2012 following net flows of $121 billion in 2011. Investors finished the year with $3,204 billion in bond mutual funds.  Taxable bond funds gained $264 billion in 2012, while tax-free bond funds grew $52 billion.  That bond funds were growing in spite of solid stock market returns is an indicator that investors have become more conservative.

This continues a trend that we have seen since the financial crash of 2007/2009.

The $90 billion withdrawn from U.S. stock mutual funds was the largest total since 2008, when $136 billion was removed. Since 2007, when the stock market hit a historic high, almost $405 billion have been withdrawn from U.S stock mutual funds. Before 2008 when stocks dropped 40%, it was normal for stock funds to draw twice what bond funds drew. It was also rare for more money to flow out of stock funds than in, during the given year.

The growing popularity of Exchange Traded Funds (ETFs) is another factor affecting flows into mutual funds.  ETFs bundle together a variety of investments in a particular market index.  While U.S. stock mutual funds saw $90 billion in net withdrawals, Domestic Equity ETFs gained $91 billion in assets following $48 billion in net new flows in 2011.

International equity ETFs gained $48 billion in net new deposits after gaining $21 billion in 2011.  Bond ETFs gains $52 billion in 2012, following $44 billion in gains in 2011.

The potential for rising interest rates could potentially hurt bond fund investors short-term, because previously issued bonds pay lower interest than newly issued bonds which will be paying higher rates. This will lower the value of existing low rate bonds since a bond fund’s return is a function of the bond price changes as well as the yield, or interest payments that the bonds generate.  Many investment advisors are predicting that the popularity of bond funds will wane as time passes between the financial collapse of 2008 and fear of a second recession recedes.

There is still a lot of uncertainty affecting stock investors as the U.S. debt is $16,471 billion and climbing. Congress also still has to deal with sequestration, the debt ceiling, political instability in the Middleast and a U.S. deficit which is likely to exceed $one trillion for the fifth year in a row.  These issues mean that stocks have a great potential for volatility.

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