As Fear Gripped Markets, Even Reliable Mutual Fund Strategies Didn't Work

Fleeing Funds
By Nancy Trejos and Alejandro Lazo
Washington Post Staff Writers
Sunday, October 5, 2008

It's been a rocky year for all investors, but for those who parked their money in mutual funds, it's been downright shocking.

The public's crisis of confidence in the stock market, in the economy and in the country's political leadership pummeled virtually all mutual funds in the third quarter, with 87 percent ending in the red, according to the market research firm Lipper. September was particularly brutal as the government takeover of the mortgage giants Fannie Mae and Freddie Mac, the near failure of the insurance powerhouse AIG, and the very real failure of several large commercial and investment banks further stoked investors' fear that a deep recession was on the way. In just one month, 93 percent of mutual funds lost money, confounding the many investors who rely on them for retirement income.

It didn't matter if the funds were invested in big, quality companies or mid-size ones, in domestic stocks or global ones, in utilities or commodities, in stocks or bonds. Most every mutual fund category got hit.

"The quarter could be defined more so as a quarter gripped with fear, and I think all the diversification strategies, all the asset-allocation strategies that tend to work in a rational market basically didn't work," said Bob Froehlich, vice chairman of DWS Investments in New York.

Even those funds considered most safe -- money-market mutual funds -- nearly imploded this quarter when a major fund announced that it was devaluing shares after the value of its investments dropped. In a period of seven days, investors pulled out a record $169 billion from money markets, and the federal government agreed to insure the funds for a limited time.

"There was nowhere to hide," said Adam Bold, founder of the Mutual Fund Store, an asset management firm in Overland Park, Kan. "Stocks were down, bonds were down, commodities were down. There was nowhere to go."

So investors went to the next-safest places they could think of -- U.S. Treasury bills and cash. What was notable about the third quarter, and September in particular, was that investors fled both stocks and bonds to seek shelter, said Conrad Gann, president and chief operating officer of TrimTabs Investment Research, which tracks the flow of money in and out of mutual funds.

"Because of the credit problems, they are worried about defaults on bonds. Everybody is going to the safest forms of cash they can find," Gann said. "People are scared; they don't want risky investments. There is risk aversion . . . in all of its forms, credit or equity."

Money has been pouring out of mutual funds all year. In the third quarter alone, investors pulled $89.3 billion out of global and U.S. mutual funds and $19.1 billion out of mutual funds that invest in bonds, according to preliminary data from TrimTabs.

There is still much uncertainty as investors enter the final quarter. Whether there is a recovery depends in large part on how a federal bailout plan is implemented. If the bailout succeeds, it could ease the credit crunch that has toppled so many financial institutions and diminished the wealth of not just those who had a lot but of those who had a little. That could calm investors and restore stability to the stock market.

Investors are also keeping a close watch on the Federal Reserve's moves. Will the Fed cut interest rates, and if it does, will the European Central Bank and the Bank of England follow suit? The other cliffhanger bringing unease to the markets is the presidential election.

"Right now, with the uncertainty of the election, the bailout plan, there's just people so unsure of what's going to happen," said Wendell Perkins, chief investment officer of Optique Capital Management in Milwaukee. "Once we can get through the November election and we have a clear and decisive winner -- I don't think it matters who it is -- I think that will go a long way."

CONTINUED     1           >

© 2008 The Washington Post Company