Fund Managers Deal with Market Fears
It’s been a tough year for the stock market—and an absolutely brutal one for mutual fund investors. The wild swings in August were particularly unnerving: Investors pulled $30 billion from U.S. stock mutual funds in the week ended Aug. 10, amid the biggest flight since a month after the failure of Lehman Brothers in September 2008. For the seven months through July, net withdrawals totaled $17.8 billion, following outflows of $280 billion from 2008 through last year, according to the Investment Company Institute. All of which confirms a long-term trend: Investors are fed up with poor returns and volatility. “You can’t keep having bombs, so to speak, go off,” says Andrew D. Goldberg, a market strategist at JPMorgan Funds. “If the second you walk outside another one goes off, you’re going to stay inside for longer.”
Some investors may be gone for good, even if the market rallies. The baby boomers represent the largest group of investors in mutual funds, according to Geoffrey H. Bobroff, an investment-management consultant in East Greenwich, R.I. As they go into retirement, they might not return to equities after enduring two bear markets over the past decade. “They are already thinking now about their retirement years,” he says. “They may be in fixed-income of different flavors, but equities may no longer be on their horizon.” The younger generation is also disenchanted. A June survey by asset manager MFS Investment Management found that 40 percent of Gen Y’ers (ages 18-30) agreed with the statement, “I will never feel comfortable investing in the stock market.”
Right now, that’s understandable. According to a report by JPMorgan Chase, 47 percent of 2,806 funds the bank tracked have trailed their benchmarks by more than 2.5 percentage points this year, the highest proportion in 13 years. The list of laggards includes some celebrated portfolios. The country’s largest stock fund, American Funds’ Growth Fund of America, fell 8 percent this year through Sept. 6. The Fidelity Magellan Fund lost 12 percent. The Fairholme Fund, managed by Bruce Berkowitz, named Morningstar’s domestic stock fund manager of the decade in January 2010, declined 27 percent. By comparison, Standard & Poor’s 500-stock index lost 6 percent over the same period, dividends included.
Money managers struggled to keep up with the market fluctuations tied to the credit downgrade of U.S. Treasuries and recession worries in August. “The market fell sharply early in August and managers sold,” says JPMorgan equity strategist Thomas J. Lee. “But we had a big rebound lasting a few days, and it drew people back in. Then another down move. That type of whipsaw triggers underperformance.”
The poor performance of mutual fund managers tells the story of a nervous and confused stock market, where larger economic concerns are overwhelming positive company fundamentals. “We’re dealing with a culture of Armageddon hypochondria,” says James W. Paulsen, chief investment strategist with Wells Capital Management. “The mindset is so skittish that even evidence of an economic soft patch is immediately extrapolated to recession or depression.”
Paulsen, for one, refuses to be so reflexively bearish. “How do you have a recession when so little is left to recess—no more excesses to correct?” he asks. He points to corporations that have pared costs, record-low mortgage rates, and falling energy prices as factors that should be boosting the stock market. Paulsen figures the market could recover to trade at a price-earnings ratio of 16 times estimated profits, rather than its current 12. Yet he concedes that investor fear could feed on itself, sending the market even lower in the near term.
Many indicators are positive for stocks. Corporate profits have ascended to a record, fully double where they were a decade ago. Those earnings have helped strengthen corporate balance sheets. Nonfinancial companies in the S&P 500 hold about $1 trillion in cash, also a record. Meanwhile, Treasury yields are at record lows; after inflation you are actually losing money by buying and holding a 10-year government bond.
The big price swings in August may turn out to be a blessing for some fund managers. “I wouldn’t say that volatility makes it harder to pick stocks,” says Russel Kinnel, director of mutual fund research at Morningstar. “It makes it easier because stocks are more likely to hit your buying price. Temporarily, it makes it harder for good stockpickers to shine, but their goal is long-term, so that’s not really a problem.”
JPMorgan’s Lee agrees that the volatility may spur investors to snap up beaten-down shares. “There are reasons to be optimistic about September,” he wrote in the report, “as dislocations, generated by ‘seismic’ shocks to risky markets in August, create relative value opportunities.” The recent underperformance of mutual fund managers could turn out to be a positive as well. “When active managers trail, there is a tendency for markets to rise into” the end of the year, he wrote. The reason: Managers feeling the pressure to catch up with the market put money to work aggressively, and their buying helps boost share prices.