Investors flee US stock funds despite new highs

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In a sign that suggests investors don’t trust the rally that’s propelled the stock market to all-time highs, cash is still being yanked out of mutual funds that invest in U.S. shares at a steady clip.

Blame it on fear of stocks at record levels. Or lousy fund performance. Or “Brexit’ fallout. Or the rise of cheaper exchange traded funds that trade like stocks. Or the demographic shift creating an older populace that craves investment income and bonds.

The fact is Main Street continues to bail out of domestic stock mutual funds, continuing a trend that’s been in place for years.

In the week ended July 20, the latest data available, money leaving domestic stock mutual funds outpaced cash coming in by $10.3 billion – the largest weekly outflow since November, according to data from the Investment Company Institute, a mutual fund trade group.

In 2016, domestic stock mutual funds have suffered net outflows in 27 out of 29 weeks. Since Britain voted on June 23 to exit the European Union, a decision that shook up investors, U.S.-focused stock funds have suffered an estimated $28 billion in net outflows, compared to inflows of nearly $16 billion into bond mutual funds, ICI data show. In the three weeks ending in July, investors yanked more than $20 billion out, a period that coincides with the Standard & Poor’s 500 stock index hitting record highs for the first time since May 2015.

Mutual funds invest in a basket of stocks, providing diversification not available in single-stock investments. A drawback of “actively managed” mutual funds run by stock pickers is they are close to fully invested at all times, which makes it hard to limit losses in down markets. And unlike exchange traded funds — which trade intraday like stocks and are passive in nature as they track stock indexes – buy and sell orders for traditional mutual funds are priced at the fund’s closing net asset value at days end.

So what explains why record-high stock prices aren’t enough to lure mom-and-pop investors into U.S. stocks via mutual funds? Theories include:

* Still haunted by past crashes. Bad memories of the dot-com stock bust of 2000 and 2008-09 crash during the financial crisis make it hard for investors to trust the stock market. Belief in buy-and-hold has diminished.

“What we’re seeing today in investor behavior is psychological scar tissue from 2000 and 2008,” says Dave Haviland, managing partner of Beaumont Capital Management. “Individuals, especially those in or close to retirement, have finally realized that most mutual funds are designed to keep investors in the market, even in periods of market failure.A lot of investors are cashing out of mutual funds in droves because that’s the way they know how to avoid losses.”

* Scary world feeds fear. With the world an uncertain place these days, thanks to terrorism, slow global growth and political uncertainty, investors are in a perpetual state of anxiety.

“Retail investors are nervous in the wake of global uncertainties,” says Nick Sargen, senior investment advisor at Fort Washington Investment Advisors. “With the stock market looking pricey now, I don’t see a quick reversal with uncertainties about Europe, China, corporate profits and the U.S. election.”

* Lousy performance. Actively managed mutual funds, or ones in which stock pickers try to beat a market benchmark, have fared poorly this year, lowering the appeal of these funds, which charge higher fees than low-cost ETFs, adds Sargen. In the first half of 2016 only 18% of mutual fund managers posted better returns than the Russell 1000 large-cap stock index, the worst year since 2003, Bank of America Merrill Lynch data show.

* New high blues. With the bull in its seventh year and stocks at record levels, investors fear getting in at the top, says Todd Rosenbluth, director of ETF and mutual fund research at S&P Global Market Intelligence.

“As the bull market ages and amid signs of greater global market volatility, investors have become more skeptical that the U.S. equity market can continue to move higher,” Rosenbluth says.

* Confusion reigns. In a world where stocks are trading above historical valuations and sovereign banks in places like Japan and Europe actually charge depositors interest to keep money at the bank, investors balk at being fully invested.”My guess is that investors are bewildered,” says David Kotok, chief investment officer at Cumberland Advisors.

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