Stuck in a soft patch
Investors move cautiously amid a traffic jam of concerns including the war in Iraq, slow job growth, and the rising price of oil.
If the past quarter were a major roadway, it would be covered with mud. For the entire summer - for most of the year, in fact - mutual-fund investors have been spinning their wheels. And they're driving with caution.
Who can blame them?
Everywhere they look, uncertainty looms - from the Iraq war to the choice of president to the nation's slow-motion recovery.
The cautious outlook has led to cautious action, which could be seen in the fairly modest amount of new money investors poured into mutual funds, the types of funds they chose, and the relative weak performance of different fund categories.
In July, for example, investors added only about $8 billion to stock funds, according to Lipper Inc. That's the lowest total since inflows turned consistently positive in March 2003. In August, the total rebounded somewhat to about $11.5 billion - but still remained low compared with the last 18 months. Meanwhile in July and August, investors added about $1.3 billion to bond funds and took out some $16.4 billion from money-market funds.
While much of the money-market withdrawals went into stock and bond funds, experts are concerned that people are not investing enough of their money.
"It is a concern, yes," says Don Cassidy, senior analyst at Lipper. "We're seeing a larger pattern which probably has been created by the overall constellation of worries. The election. Terrorism. The lack of job creation. Also, people are no longer able to refinance their houses at cheaper and cheaper rates, and that's slowing down their cash flow, which makes less money available for investing."
Even the few winning fund categories of the third quarter reflected this caution. To find the best-performing funds, as well as the ones that took in the most money, all an investor had to do was look for funds that included "gold," "real estate," or "natural resources" in their names.
In many cases, looking for natural resources really meant prospecting for oil. With oil prices sloshing around $50 a barrel as the quarter ended, natural-resource funds gained 10 percent for the quarter. Consumers, of course, had to shell out more for gasoline while they anticipated paying more for heating oil this winter. But higher prices helped oil and gas companies - and their equipment suppliers - reap larger profits.
Periods of uncertainty traditionally benefit gold funds, and the past three months were no exception as these funds gained nearly 15 percent.
"There is some element of caution out there," says Bill McNabb, managing director of the Vanguard Group in Valley Forge, Pa. "There's certainly a lot of geopolitical uncertainties."
Real estate funds also did well, gaining more than 7 percent during the period. "People are going there because they can find the comfort of current income and value," Mr. Cassidy says. "The REITs [real estate investment trusts] under those funds have real shopping malls, real apartment buildings. It's not some stock with a story; it's value and income and that's what people are after."
If there was a winning exception to the "caution pays" trend, it was Latin America. Led by strong performances from Brazil and Venezuela, the average Latin America fund gained more than 15 percent during the period, Lipper says. After long periods of political and economic uncertainty, both countries seemed to have stabilized this year, Cassidy says. "So it's a bit of a relief rally."
Most categories of stock funds had negative returns during the period, but those with a cautious investing style (so-called value funds) did better than their more aggressive counterparts (called growth funds). The average large-company value fund, for example, lost a little less than 1 percent during the period, while the average large-company growth fund lost more than 4 percent, according to Lipper.
Value stocks and funds became more attractive when Congress cut the tax on corporate dividends to 15 percent, says Jay Mastilak, a senior financial consultant at PNC Bank in Pittsburgh. Previously, dividends were taxed at the investor's top tax rate. "That makes these stocks very attractive," Ms. Mastilak says. "In addition, we have dividend yields greater than what we can get in short-term products like money-market accounts. So we have an investment that's paying a very attractive rate of return compared to other investments as well as being attractive on a tax-managed basis."
There is a possible downside to the current focus on value funds, Vanguard's Mr. McNabb notes. Whenever one type of investment - whether it's value funds now or technology funds in the late 1990s - greatly outperforms other categories, there is a potential for a quick reversal.
"The performance gap between value and growth is getting to be very extreme at this point," he says. "When you see these kinds of performance disparities between one style and another, eventually they reverse. The wider the gap, the higher the probability that that reversion is coming."
So investors shouldn't try to chase performance by putting all their money into value funds.
"It's important for people to keep their long-term goals in context," PNC's Mastilak says. In spite of news about the election, unemployment, oil prices, Iraq, and terrorism, investors need portfolios that reflect their long-term needs and goals, she says.
"It's not an issue of who's going to be president in several months, but 'Do I have enough to retire on? Do I have enough to pay for my child's college education? And how do I get there?' "