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Even With War Rally,Bond Flows Still Dominate

In spite of the eight-day war rally in the middle of last month that drove major equity indexes up 11%, investors are still exercising caution, Lipper reported last week. Bond funds remain the strongest-selling sector among mutual funds.

Fixed income funds took in $9.8 billion during March, while equity funds had net flows of $1 billion. However, because of a loss of $26.9 billion from money market mutual funds, primarily due to their returns of less than 1%, the industry lost $16 billion from all types of funds during the month. Forthcoming data on the month will probably show that investors slowed their equity fund redemptions, rather than rushing to buy stock funds, Lipper said.

While flows into equity funds were essentially a breakeven, the good news for the industry was that it reversed eight months of equity outflows.

But even among equity funds, the types of assets being bought reflect caution, Lipper analysts said. Traditional diversified stock funds lost $600 million, while mixed equity portfolios - balanced, income and convertible securities - took in $1.6 billion, Lipper said. And much of the trading volume in equities was fueled by short sellers.

Much Ado About War

Despite all the talk about the beneficial effects of a victorious war as the conflict in Iraq began, even with the end of the war in sight, investor and media attention has returned to weak earnings and the sluggish economy, Lipper analysts noted.

Among bond funds, high current yield taxable funds took in 90% of all net money moving to long-term taxable funds. Short/intermediate and taxable high yield were among bond best sellers. It is worth noting that last November, the last month when bond funds had strong inflows in the same month as a market rally, bonds took in $7 billion. The $9.8 billion flight to bonds last month reflected heightened aversion to the stock market, Lipper analysts said, adding that anecdotal reports from defined contribution administrators indicate people are moving more of their 401(k) money to fixed income.

"Clearly, investors in both stocks and funds remain in a show-me mode. Fear is a major driver," Lipper said. "We suspect it will take time for equity funds to return to consistent inflows." This should be of great concern to the fund industry, as equity funds "carry the higher management-fee rates and have traditionally been the primary engine of asset and profit growth for the fund business," Lipper said.

U.S. Equity Appeal

One positive development during the month for stock funds was the return of investor interest in U.S. equity markets. S&P 500 index-objective funds enjoyed inflows of $1.3 billion, while world equity funds lost $900 million, after a string of positive months. "The sharp aversion to the U.S. equity market abated, [and] world equity funds lost some of their relative allure." Lipper said. In addition, the stabilization of the U.S. dollar took away some of the international funds' allure.

While broad indices regained favor, sector funds as an aggregate group continued to fall by the wayside, losing a net $600 million, their 12th straight month of outflows, during which time they have lost $15.1 billion. Only real estate funds had an inflow, of $150 million. Science and technology funds endured the worst outflows, losing $200 million. Utility funds saw $175 million walk out the door. Even gold-oriented funds lost money, bleeding $70 million.

Investors' hesitance to buy sector funds, which represent aggressive choices, underscores the fact they are "not in a very self-confident frame of mind or seeking brave options," Lipper said.

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