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Fund Redemptions Get Serious

Mar 10, 2009
Max Rottersman

Mutual fund redemptions are exerting downward pressure on today's equity prices in a process that began years ago

HANOVER, NH (ETFguide.com) - Since September, two, out of every $10 dollars, have moved from equity to money market funds.  The Nation's ATMs stand ready to dispense a trillion dollars worth of mattress filling cash.  Was it possible to mobilize all this money without further bringing down the stock market?  No. You can't expect mutual funds to sell 20% of their equities within 60 days and get good prices for them. 

One could make the argument that massive selling depresses the stock market.  One could also argue that  buying raises prices.  According to this logic, once it occurs to everyone that equities are a better inflationary hedge than cash, the money will grudgingly pour back into equities, revitalizing the stock market. 

Unfortunately, some mutual funds may never recover.  The same problem that bedevils social security has been eating away at retirement oriented mutual funds.  The problem is simple.  Baby Boomers are now taking more money out than younger people are putting in.

In the 1980s through the 1990s the flow was working in the Baby Boomer's favor.  They were putting more money into the market (from earned productivity) than anyone was taking out, thereby putting upward pressure on stock values. 

Now it looks like getting one's money out, at 1990s prices, is not so easy.  I wonder, will Baby Boomers get more value from social security or their 401(k)?  Will the government raise taxes (on young people) to bolster social security, or it will create tax loopholes to favor fund accounts.  It's a rhetorical question of course.  The wealthy part of the population always get itself a better deal.  But I digress.

To illustrate the problem of legacy mutual funds, I'm using one of the strongest fund companies, American Funds, which are sold by thousands of true-believer financial advisors.  The funds have enjoyed good returns, which I attribute to that hot money I mentioned, but that's a story for another day.  

Exhibit A is the Investment Company of America Fund (Nasdaq: AIVSX).

 Chart

The green lines show new shares that were bought each month, the red lines are shares that were redeemed.  The dark blue lines are the net effect, either net sales or net redemptions.  For the past few years this fund has been experiencing net redemptions.

What confuses even professionals, is that the change in stock prices masks the shrinking of mutual funds.  In the case above, the fund had $76 billion at the end of 2004 and $54 billion at the end of 2008.  One might chalk-up the decrease to bear market forces.  But if we calculate what should have happened to those assets through market appreciation, we find that the fund should have ended up with $65 billion, not $54 billion.  Where did the other $11 billion go?

The answer, according to the fund's filing with the SEC, is that over the past few years the fund actually lost $14.4 billion in net redemptions.  However, one would find that the number of shareholders have gone up, not down, from 3.9 million to 4.1 million.  How can that be?

Again, this is the demographic curse.  A Baby Boomer starts their account with ten thousand, but will probably close out a hundred thousand.  This means a fund would need ten new investors to make up for every retiring shareholder.

No fund is immune to these pressures.  Here's Fidelity's best five-star fund, the Fidelity Contrafund (Nasdaq: FCNTX).

None

The Contrafund has shed about $4.5 billion in net redemptions since June of 2006. 

If we look at the industry's total equity fund assets at the end of 2005, according to the ICI, we find $4.9 billion.  At the end of 2008 it was $3.7 billion, the exact amount we'd arrive at if we put the entire amount in the Vanguard Total Stock Market Index (Nasdaq: VTSMX).  

I next looked at American Funds Growth Fund of America (NASDAQ: AGTHX), which is their largest, most successful fund.  It too is succumbing to size constraints. 

agthx

If my estimates are correct, The Growth Fund Of America is in net redemptions.  If the trend continues, will fund performance suffer from the continual selling of portfolio securities to meet redemptions?  To compare American Funds, and others, you can use this mutual fund database.

Mutual funds appear to be slipping into long-term net redemptions.  New money, however, is entering the market through ETFs. 

Here are a few ETFs that are succeeding in gathering fund inflows: iShares Barclays TIPS Bond (NYSEArca: TIP), now at $10 billion; iShares Barclays 1-3 Year Treasury Bond (NYSEArca: SHY) at $7 billion;  United States Oil (NYSEArca: USO) at $4 billion and a random pick, the CurrencyShares Euro (NYSEArca: FXE).

Max Rottersman is a principal of Hanover Technology Group, LLC. His opinions dont necessarily represent the views of ETFguide.com or Yahoo Finance.

 

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