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Record Redemptions Offset Record Sales

Mutual fund redemption rates continued to rise faster than gross sales last year as investors spent some of their investment gains on luxury purchases and reinvested other gains in non-mutual fund investments, according to a new report.

Long-term mutual funds set a record last year with approximately $1 trillion in redemptions, up from approximately $747 billion in 1998, according to Financial Research Corp. of Boston, a mutual fund tracking and consulting firm. That increase in redemptions minimized the effect of what had been a record year for gross sales for the industry in 1999. Gross sales totaled roughly $1.2 trillion, according to FRC, in a report it made public March 9.

Redemptions constituted 85 percent of gross sales last year, up from 75 percent in 1998, FRC reported. Redemptions as a percentage of gross sales ranged from 50 percent to 65 percent prior to 1998, FRC reported. New net cash into long-term funds decreased by 30 percent, from $241 billion in 1998 to $169 billion in 1999, according to FRC.

Last year's results continued what has become a trend for the mutual fund industry. Since 1997, the increase in gross sales has been slower than the increase in redemptions, FRC reported. (See accompanying chart)

The rise in redemption rates seems likely to continue until net redemptions force more funds to liquidate or merge and fund advisors to merge, said Charlie Bevis, the FRC senior analyst who wrote the report.

"I think living with high redemption levels is going to be a fact of life for fund companies for the next year or so," Bevis said. "I don't think there is going to be some miracle cure."

Investors used an estimated 35 percent of the proceeds from their redemptions to pay for personal expenses such as luxury items, Bevis said. Sixty-five percent of the redemption proceeds were reinvested in a mix of long-term mutual funds, stocks and alternative investment products, FRC estimated.

Those reinvested proceeds went into a variety of vehicles including managed accounts in defined contribution plans, exchange-traded funds and stocks, in addition to mutual funds, Bevis said. Some companies in recent years have been switching assets in their defined contribution plans from mutual funds to managed accounts. Company executives contend such switches reduce investment management expenses. Fund companies frequently argue that their institutional mutual funds have expense ratios competitive with managed accounts.

Although there is no conclusive supporting data, anecdotal evidence suggests that there was an increase in the percentage of investors who reallocated their investments into non-mutual fund products in 1999 compared to 1998, Bevis said.

FRC's analysis follows a report that the Spectrem Group of San Francisco issued March 1 based on a survey of approximately 2,600 households that owned stock or bond funds. Forty-seven percent of those responding to the Spectrem survey said they used the proceeds of their redemptions to buy another equity fund and six percent said they bought another bond fund. Another 11 percent used the redemption money to purchase individual stocks, Spectrem reported.

Spectrem, a research, consulting and investment banking firm, conducted the survey by mail from June 24 to July 26, 1999.

The movement by investors into alternative investment products such as exchange-traded funds and managed accounts for retirement plans poses a challenge for fund companies, Bevis said. Competition with non-traditional products like exchange-traded funds and commingled funds may reduce the effectiveness of traditional asset retention strategies, Bevis said.

Fund companies historically have used strategies such as redemption fees and special retention campaigns to hold on to shareholders who might switch to other fund groups. Fund executives now need to consider developing new types of products such as managed accounts and distributing products in foreign markets to increase their retention success, Bevis said. Fund companies that can provide distribution services also improve their business prospects, Bevis said.

"You have to be more than a mutual fund manufacturer to be successful," Bevis said.

Currently, 303 of the roughly 13,900 funds in existence have redemption fees, according to Lipper of Summit, N.J., the fund tracking and consulting firm.