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Financial Times. 6/27/01

Home economics rule overseas funds

Elizabeth Wine

The behaviour of mutual fund investors is usually easy to predict—it generally correlated with the markets—but it seems that the relationship breaks down when it comes to overseas funds.

Investor’s attitudes to international funds is driven not by the performance of international markets but by the US market itself. This is a worrying sign of investor irrationality, given the point of investing internationally is for diversification away from the US.

Look, for example, at what happened last December when the Morgan Stanley Capital International World Index went up 2 per cent. In the same period, investors pulled $4bn out of overseas funds, according to fund tracker Lipper.

The same sort of mentality was at work last month, according to Lipper. In May, shareholders sent equity funds $11bn but pulled $2.2bn out of those stock funds investing overseas. This was a complete reversal from April, when they sent $2.7bn to world funds.

“This was just a general case of ill ease,” says Don Cassidy, analyst at Lipper. “When they feel good they feel more self-confident about doing things like investing overseas.”

Granted, the MSCI World Index suffered a decline of 1.5 per cent in May, almost twice the 0.82 per cent drop in the Standard & Poor’s 500 index. It is not surprising investors pulled money out of lossmaking funds. But the $11bn inflow to all stock funds does not represent a proportional pull-back from US funds.

US markets have outperformed the rest of the world over the last five years. But analysts say that investors are not examining the performance of individual markets when deciding when to pull money out of funds. They are simply running for cover if the US market quakes.

They say this is because the average US investor associates foreign investment with greater risk, regardless of what kind of companies an overseas fund manager is investing in.

Further, even though US investors have grown more sensible about their domestic investing, sending 95 per cent of the inflows to US diversified funds, it is not as though they have stopped taking risks.

Sector funds, which represent the most concentrated bets, pulled in a modest $600m in May. This came even as the formerly popular science and technology funds and telecommunications funds shed 4.27 per cent and 6.49 per cent respectively of their value in the month. The latter was the worst performing equity fund category but investors did not punish these funds for such underperformance. Science and tech funds had zero flows, while telecoms suffered just $100m in redemptions.

European Union citizens have an economy as large and as politically stable as the US. A blue-chip European stock fund is simply not comparable to a focused sector fund in terms of volatility or downside risk. Yet US investors behave as if it is much riskier.

John Olienyk, professor at Colorado State University, says that this parochial behaviour hurts investors rather than shelters them from excessive risk.

“In this sector investors seem to be skittish, and when the US markets are doing well they fell like taking on a little bit more of that risk they perceive is in the international funds. When stock prices are coming down in the US, and they want to reduce exposure to stocks, they tend to reduce exposure across the board instead of just here. But by doing so they’re behaving contrary to what principles of diversification would dictate,” he says.

However, Mr. Cassidy notes there is a very strong correlation over the past 24 months between the mood of the US stock markets and the cash flows into overseas funds.

Starting around the summer of 199 with the rapid boom in US stock markets, flows into international funds began to pile up. The inflows culminated in January and February last year when stock funds brought record inflow of $40bn and $53bn respectively.

But since the top of the Nasdaq market last March, flows into international funds have declined. Overseas funds suffered net withdrawals in six of the last eight months, amounting to $21.3bn. Those were offset by just $7.2bn in inflows over the other two months.

But as US markets stalled, investors merely curbed their enthusiasm for domestic funds. They pulled out just $24bn more than they sent in between February and March. The other months of the year through May have brought in $50bn.

Analysts do not hold much hope that investors will see the error of their ways.

“It’s human nature to buy high and sell low. You buy when you’re excited and don’t buy when markets are low because you’re scared,” Mr. Cassidy says.

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