Emotions And Fund Problems: Keeping A Cool Head During Troubling Fund Times

The whole mess reminds him of a scene from of an old movie where folks--- worried about the safety of their money--- started a run-on-the banks. This time, he's wondering whether there could be a run-on-funds.

"I know my reactions are emotional, " says Shinbrood, the president of Treasure Coast Software, "But the whole thing is driving me crazy."

My guess is, Shinbrood isn't alone in his feelings. Whenever Wall Street headlines read "scandal", odds are investors will worry long enough to let their emotions get the best of them. So to keep you grounded, let's put our emotions aside and look at some facts:

First, it's not likely that the stock market will crash and burn simply because fund investors sell their equity fund shares. Don Cassidy, senior analyst at Lipper, Inc., said that funds own about 15 percent of the U.S. equity market. "People are not selling all of their funds," he says. "However, some are pulling out of some of the most prominently named offending firms like Putnam and Strong. But, since September 3, when the Spitzer disclosure happened, the market is up, not down. There is no run on funds."

Cassidy's point is well taken. Yes, there have been redemptions from funds, but those redemptions haven't brought the market to its knees-or for that matter, anywhere close to them. To date, both Janus' and Putnam's assets have fallen by billions and Alliance Capital by millions. No doubt there will be more money leaving all of the fund families involved but how much still remains to be calculated.

Second, an equity investor is an equity investor. If you've the stomach for stocks and understand that stock prices fluctuate daily, monthly, annually, and that the market as a whole with always have ups and downs, if you sell your equity fund shares and reinvest that money into individual stocks, or exchange traded funds, you'll still be a stock market participant. Cassidy said that redeeming fund shares and owning stocks is "a wash in terms of money flow in the market".

Third, redeeming shares and a fund's net asset value. One of the pluses of mutual fund investing is that investors are able to redeem their fund shares any business day of the week. To cover those redemptions, portfolio managers typically keep anywhere from five to 10 percent of their fund's assets in cash. (Figures vary from fund to fund and when market is strong, funds may hold smaller cash positions.)

Whenever there are redemptions in a fund that exceed the cash amounts held---say caused by market-timers or a rush by investors to exit the fund--- portfolio managers have to sell portfolio holdings to raise the cash to pay the exiting fund investors.

"If the manager has to sell under distress, it doesn't hurt the guy who is getting out, but could impact the little guy holding on, " says Steve Schoepke, vice president of research and product development at AIG SunAmerica. "And (selling under distress) increases the likelihood that there could be a loss in the fund's net asset value."

How much an impact the selling has on a fund's net asset value, however, is difficult to predict and depends upon the fund and market conditions.

"The commission for selling stocks do hurt the fund NAV a little, " says Cassidy. "In a normal year, commissions may run a half of one percent of a fund's total net assets. So a little extra forced selling could cost a few basis points."

Fourth, don't confuse today's fund industry problems with those of Enron's or WorldCom's--that would be like comparing apples with oranges.

Enron and WorldCom are each individual companies. One of the strengths of mutual fund investing is that a stock fund's portfolio isn't made up only one or two stock holdings but a few dozen ---or even hundreds of individual names. So if there's ever a problem with a security, or securities, the diversify of the fund's portfolio can cushion the blow.

"You have to be a very strong individual to not let your emotions get the best of you, "says Schoepke. " But the fact is, these are very large companies with a lot of compliance safeguards and a lot of money. There is value in these funds (and their fund families) so be careful not to confuse the issues and over-react. "

Finally, any losses fund shareholders have incurred will be paid back. Cassidy says that the amounts that individual shareholders may have lost is likely to be quite small per fund per shareholder. " Maybe $10 or less for small/average accounts, " he says. " People will get reimbursed, even if they no longer own the funds. The computer records are all there and the recoveries will be apportioned. But this will take months, not days, to figure out."