Personal Investing

A Boom in Bonds Hurts Mutual Funds


Burned by two market crashes in a decade, investors have shunned stocks for the longest stretch in more than 23 years, upsetting the balance of power in the $10.5 trillion mutual fund industry.

Bond funds attracted more money than their equity counterparts in 30 straight months through June, according to the Investment Company Institute, a Washington-based trade group. Preliminary data show the trend continued in July, matching the streak posted by bonds from 1984 through 1987. Bond funds pulled in $559 billion from January 2008 through June of this year, according to ICI, while investors pulled $209.4 billion from domestic equity funds and $24.4 billion from funds that buy non-U.S. stocks. "Retail investors are still shocked by what has happened in the past two years," James Kennedy, chief executive officer of fund manager T. Rowe Price (TROW), said in July after releasing second-quarter earnings that fell short of analysts' estimates.

The shift is pressuring asset managers, especially equity-focused firms such as Janus Capital Group (JNS) and Capital Group, because bond funds charge investors about 20 percent less in fees. The average stock fund collects 76 cents in fees for every $100 invested, compared with 61 cents for bond funds, according to Denver-based fund research firm Lipper.

Among the big winners are bond specialist Pimco and Vanguard Group, whose index stock funds have become popular alternatives to actively managed portfolios. Only 1 of the 10 best-selling mutual funds in 2010, the $117 billion Vanguard Total Stock Market Index Fund (VTSMX), invests exclusively in stocks, according to research firm Morningstar. Its success shows that even when investors put money into stocks, they prefer index-based funds over those that are actively managed.

The impact can be seen in return on equity, a measure of profitability, reported by publicly traded asset managers. At T. Rowe Price, ROE fell to 22 percent in the second quarter from 26 percent in the fourth quarter of 2007, the last period before the bond-dominance streak began. At Franklin Resources (BEN), which manages $603 billion in the Franklin and Templeton funds, among others, ROE declined to 19.5 percent from 26 percent in the second quarter. Equity funds dropped to 41 percent of assets, from 59 percent.

Janus, with 93 percent of its $147 billion in assets in stocks, "has probably been hurt the most," says Jonathan Casteleyn, a New York-based analyst for Susquehanna Financial Group. The Denver-based company earned $61.5 million in the first half of this year, down 27 percent from the same period in 2007. Equity assets fell 28 percent during the 30 months through June as investors pulled $3.9 billion from its stock funds, and the decline in stock prices reduced the value of existing holdings. Janus' return on equity climbed to 12.1 percent in the June quarter from 5.8 percent in the final three months of 2007, when earnings were depressed by a writedown of the value of a printing unit. Spokesman James Aber declined to comment.

The popularity of bond funds plays to the strength of Pimco, whose $1.1 trillion in assets includes just $600 million in stock funds. It attracted $40.2 billion in the first half of 2010, more than any other fund company, according to Morningstar. Pimco Total Return (PTTRX), run by Bill Gross, had deposits of $20.9 billion in the period, the most for an individual fund. The $239 billion portfolio, the world's biggest, returned 5.8 percent in the first half, compared with a loss of 6.4 percent by the average stock fund.

American Funds, part of Los Angeles-based Capital Group, had $48.8 billion in withdrawals from stock funds in the 30 months ended in June, more than any other fund firm, according to Morningstar. Fidelity Investments experienced $48.1 billion in withdrawals from its stock funds in the 21/2-year period, the second most after American Funds.

Jim Jessee, president of the fund distribution unit of MFS Investment Management, says it may take a major market rally to get investors back into stocks. "Unfortunately, my gut tells me the market will need to go up 30 to 50 percent," he says. John Sweeney, an executive vice-president at Fidelity, says hanging back could be costly: "Someone who is waiting for stability is likely to miss out on the upside."

The bottom line: Investors' preference for bond funds has put pressure on earnings at companies that specialize in stock funds.

Stein is a reporter for Bloomberg News in Boston.

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