Of Mutual Interest Fund investors scared, despite 3Q stock surge Individual investors continue to shun stocks

By Mark Jewell

AP Personal Finance Writer

BOSTON (AP) -- What's it going to take to restore confidence? Investors in stock mutual funds have enjoyed gains in five of the past six quarters. Their funds finished up an average 12.5 percent over the past three months, bolstered by the best September in the market since 1939.

Yet individual investors continue to shun stocks and move into bonds. They're even venturing back into the traditional safe-haven of money-market mutual funds, although those investments continue to pay close to zero percent interest.

There's been an entrenched aversion to stocks since early 2008, and it didn't ease in the July-through-September quarter. Net outflows from U.S. stock funds hit nearly $24 billion, according to preliminary data from Lipper Inc. Meanwhile, investors stashed nearly $69 billion in bond funds, extending a run of positive net flows into bonds stretching back nearly three years. Money-market funds, which offer easier access to cash, drew in $14 billion. That's a small recovery for a category that's seen some $1 trillion walk out the door the past two years because of negligible returns.

The extreme caution amid a rising stock market leads one analyst to suggest the pain of 2008's bruising losses has permanently altered investor psychology. Lipper's Tom Roseen believes many investors have discarded traditional thinking about constructing a retirement portfolio, such as keeping roughly 60 percent in stocks and 40 percent in bonds if you're middle-aged. Many now tilt heavily toward bonds, fearing another collapse for stocks.

"People are still very concerned, and gun shy," Roseen says. "2008 was horrible. In 2009, people did not get back into the market. We certainly see that trend continuing. Even though we had a really grand third quarter, we have not seen investors follow through."

Whether investors regain their confidence in stocks depends in part on quarterly earnings reports that are just beginning to come out. A key question: Whether profit increases will be driven by greater corporate and personal spending, rather than the recession-driven cost-cutting that aided bottom lines in recent quarters.

Roseen believes we're at the start of another good quarter for stocks because the economy appears to still be growing slowly. But he's also cautious, saying the fourth quarter is unlikely to be as strong as the last one.

One reason to be careful is that the market continues to see-saw. Stock funds gained nearly 7 percent in July, only to decline 4 percent in August, then rebound 9.6 percent in September. And some scars are still fresh. The one quarter out of the last six when stocks lost money was the second quarter of this year, when stock fund's lost an average 10.4 percent.

A look at the quarter's highlights, based on Lipper fund data:

-- More than 98 percent of stock funds and funds holding a mix of stocks and bonds posted gains. The average gain for stock funds, at 12.5 percent, was the strongest since the second quarter of 2009, when the market began its recovery from the market meltdown.

--U.S. stock funds lagged their international counterparts, but still finished up 10.7 percent. Through September, they were up 4.8 percent.

-- Overseas, the top performers were Latin American funds, with a 26 percent gain. Declining fears of inflation in Latin countries helped lift the region's stocks.

--Funds that specialize in growth stocks fared better than value stocks for the second quarter in a row. Growth funds finished up an average 12.8 percent, compared with a 10.6 percent for value funds. Growth stocks generate revenue and earnings at an above-average rate -- think of Apple, and Google -- so investors are typically willing to pay a premium for them. Value stocks' profits are generally steadier, but slower-growing. Value stocks performed better than growth most of the past decade. The recent shift toward growth may prove to be a long one if stocks continue to rally, Roseen says.

-- Funds specializing in telecommunications stocks -- a big component of the growth category -- surged 19.4 percent. In comparison, the Standard & Poor's 500 index rose 10.7 percent

-- Mixed-asset funds -- primarily target-date funds geared toward building up retirement savings -- finished the quarter up 9 percent. Those funds, which hold a mix of stocks and bonds, continue to draw investors this year, bringing in a net $55 billion so far.

-- The top-performing sector fund category: international real estate funds, with a nearly 23 percent gain. The weakest performers were financial services funds, up just 5 percent. Health and biotechnology funds also lagged, rising 9 percent. Stocks in both sectors probably were hurt by the financial regulation overhaul and health care legislation that became law this year, Roseen says.

-- For bond funds investing in government debt, Treasury inflation-protected securities were the top performers, returning nearly 3 percent for the quarter. TIPS provide protection from inflation, which remains a long-term fear for many investors.

--High-yield mutual funds investing in corporate bonds carrying higher-than-average credit risk climbed more than 6 percent, the strongest result in the domestic taxable bond category. High-yield could continue to beat other categories, "if only because that's the only place people can get some decent yield now," says Jeff Tjornehoj, a fixed-income analyst with Lipper.

Lipper analysts say most of the investors who have been fleeing stocks appear to be average investors, rather than professionals running pension funds or hedge funds. Many of the big players have been moving into emerging markets stocks in fast-growing countries like China. Recent surveys indicate a growing percentage of the pros, or about half, see stocks as good deals now, which helps explain the September rally.

As for smaller investors, Roseen says, "they're still not ready to get back in."

Published: Mon, Oct 11, 2010