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Investors are showing increasing disenchantment with money managers who pick U.S. stocks. Mutual funds that invest in domestic equities have lost an estimated $8 billion to redemptions this year through June 29, putting them on track for an unprecedented five straight years of withdrawals, according to data from the Investment Company Institute. Over the 10 years through May 31, investors withdrew $51 billion more from domestic equity funds than they deposited.
Index funds that invest in U.S. stocks had positive inflows every year since 2001, according to research firm Morningstar (MORN), which means that the withdrawals have been coming mostly from actively managed funds—those where a manager chooses individual stocks. The two bear markets since the start of the century have helped discredit the idea that active money managers can beat the market consistently over time. “Actively managed domestic stock funds haven’t demonstrated that they can add value,” says Geoff Bobroff, an investment management consultant based in East Greenwich, R.I. “They have lost their mojo.”
While shunning American stock funds, investors have been adding money to bond funds, international stock funds, and exchange-traded funds (ETFs), which track indexes and invest in U.S. stocks, foreign stocks, bonds, and commodities.
Domestic stock funds captivated the American public in the 1990s, thanks to a market that rose at an annual pace of 18 percent a year and the well-publicized success of stock pickers such as Peter Lynch of Fidelity Investments. Lynch guided Fidelity’s Magellan Fund to gains of 29 percent a year from 1977 to 1990, compared with 15 percent annual returns for the S&P 500-stock index. Over the 10 years ended Dec. 31, 2000, investors poured $1.3 trillion into U.S. stock funds.
In the past 10 years the S&P 500 returned 2.7 percent annually, including reinvested dividends. In three calendar years during that period, investors suffered double-digit losses. Some fared even worse, as 56 percent of all actively managed diversified U.S. stock funds trailed their benchmarks over the past decade, Morningstar data show. “People say they invested in our markets and they netted zero in 10 years,” says Wayne Blanchard, a financial planner based in Orlando, Fla. “Many of them throw that in my face.”
After some years when investors pulled money from U.S. stock funds, including 1988 and 2002, they resumed contributions the next year. That pattern has broken down. Investors fled the funds when stocks collapsed in 2008 and continued to pull money out even when they rebounded in 2009 and 2010, withdrawing a total of $335 billion from domestic equity funds from 2007 to 2010. The fund-flow figures point to a potentially long-lasting change in American investors’ behavior, according to William Finnegan, senior managing director of retail marketing at Boston-based MFS Investment Management, which created the first U.S. mutual fund in 1924 and now manages $240 billion. “Some people are out of the market,” he says, “and they are not racing back in.”
Many investors willing to commit money to U.S. stocks are doing so through ETFs, which mimic indexes and do not rely on a manager to make investment decisions. ETFs had contributions of more than $100 billion each year from 2007 through 2010. The SPDR S&P 500 ETF, which invests in U.S. stocks, remains the largest. In 2010 and so far this year, the Vanguard MSCI Emerging Market ETF has drawn the most money. In 2009, the SPDR Gold Trust attracted the most.
Investors have flocked to international stocks to take advantage of faster growth rates in emerging markets and to diversify their holdings, says Michael Kim, an analyst with Sandler O’Neill & Partners. International stock funds gathered $491 billion in deposits in the 10 years ended May 31, ICI data show, and they have continued to draw money this year. Bond funds were the biggest winners over the past decade, attracting $1.1 trillion. They won more money than stock funds in the first five months of 2011, ICI data show. “Bonds have gone up for two decades and people have gotten comfortable with them,” says Robert Doll, chief equity strategist at money manager BlackRock (BLK), the world’s largest money manager. Bonds will remain “the preferred asset class,” he says, until people holding them suffer losses.
The bottom line: Burned by bear markets, investors have pulled $8 billion from U.S. equity funds in 2011—and $51 billion over the past 10 years.