Saturday, May 10, 2008

The Mutual Fund Run (Reprinted)

------Reprinted from May 14, 2007

There are about 8,000 mutual funds in the United States and 55,000 worldwide. Of those in the US, 4,600 were stock mutual funds. 55% of the money invested in mutual funds is invested in Stock Mutual funds (5 Trillion dollars). 48% of all of the Mutual Funds are in tax deferred accounts. Mutual funds owned 23% of all US publicly traded stocks for the year ending 2005. There is more info on this at

If the stock market turned bearish and started to drop drastically, your mutual fund portfolio would drop in value. At this point you have three choices; withdraw your funds, switch to a non stock portfolio with the fund, or do nothing. With withdrawal, you could face an early withdrawal penalty of 5% or as with the tax deferred accounts, an IRA penalty on top of that.

Notice that 52% of the investors have the option to withdraw without tax penalties. The rest probably have the option to switch from stock to money market funds. Here’s where things start to become unglued. The mutual stock fund facing redemptions has to sell stock for redemptions, and also for the transfers being made to money market funds.

The stock fund manager is sitting in his office wanting to buy the market, everything is at a discount. What’s he being ordered to do? Raise cash! So what’s he about to do? Sell into a declining market. I just hope they don't try to sell the whole 23%.

The real disconnect that I see in the mutual fund market is the interest in the foreign funds. The Asian markets are touted as a "New Frontier." My jaw can't drop that low, I'm just too old. When Templeton suggested to buy that market, the absurdity of the idea boggled my mind. Don't go there!

Foreign mutual funds in a panic could be dead meat. The natural instinct in foreign countries, in a panic, is to dump the local currency for U.S. dollars. The first thing that their government would do to stem the tide is to pass laws against repatriating the currency. In this case, you could cash in the foreign stock fund into local currency, but what good will that do, you can't convert it to US dollars? I'm not even touching on the corruption in third world Asian markets, Japan included.

So what happens if the stock market drops like a rock? The investors in these stock mutual funds are going to pull out of the fund or wish they had. This will force the money managers to sell into the abyss. In the 1930’s they called it “A run on the bank.” In 2001 it was called a 50% haircut. Get ready for the Mutual Fund Run and by the way, it's not a marathon!



Hair-raising. First out survives with least damage. But then, I've been telling my clients for the last 9 years not to get in. Which is why I have earned little. Which is why most advisers and fund managers don't say it. And good ness know what would happen to a MSM journalist who played Cassandra. That's why I've joined the blogosphere - among the madmen are some prophets.

Your foreign-equity point is useful also. A UK investment wise-owl journo called Christopher Fildes said years ago, an emerging market is one from which it may be difficult to emerge.

Tyrone said...

I haven't exactly done the math, but my 'run on mutual funds' is upwards of $500K, from both 401K and personal holdings. The problem you face is where to put the money. I withdrew cash from some, moved to short-term treasuries, money markets, small position in S&P short ETF, small position in energy and gold funds, and bond funds (yes, bond funds,... *barf*).

I performed my due diligence, and feel comfortable with the result, but it's not low risk by any means.

Jim in San Marcos said...

Hi Sack

The quote "emerging market is one from which it may be difficult to emerge," made me laugh. It's a little like a chess game. You think your safe but your not.

I'm like you, I got out of the stock market in '96. It was out of whack even then

Jim in San Marcos said...

Hi Tyrone

I was looking at my 401K and was amazed that they considered the safest investments as 30 year 5% bonds. Especially with inflation at [insert your guess here]. I switched from those to shorter term Treasury which the fund claimed were riskier. It the 30 year interest rate went to 10% those 30/5% bonds would still be worth face amount in 30 years, but I don't think I'll live to be 90 years old. At 10% interest current face on a 30/5% would be 50%. A real killer.

Something I am going to start next week is shorting a few dogs in the stock market. I tried it a long time ago, but I couldn't get to sleep on the weekends because of the potential stress involved.

The thing that counts most is a good nights sleep. A bad investment can really ruin that!

Thank you for your post