Are Investors Pulling Money Out of Funds Too Fast?

Lately, there haven't been many good days. Sure, a down stock market should reveal dozens of potential bargains. And Nygren and his team have one of the best long-term records among value mutual fund managers. But there's just one problem: He's a fund manager who can't, well, manage funds. Investors, spooked by the market and sensing better opportunities elsewhere, are consistently pulling money out of Oakmark Select, and Nygren doesn't have enough money to buy the shares he wants to buy — even though he's finding plenty of bargains. While he still has confidence in the fund's long-term strategy, he just can't get ahead in the short term. "You are selling stocks you would rather be purchasing," he says.

As if trying to beat the stock market weren't a big enough challenge, U.S. stock-fund managers are encountering a problem that's potentially trickier: trigger-happy customers. Although it's not surprising that the market's fall would increase sell orders, the pace of today's nervousness has caught many managers off guard and taken money right out of their hands. Since the recent market downturn started in October, investors have withdrawn almost $69 billion more from domestic stock funds than they have deposited, moving much faster than they did from 2000 to 2002, when they endured two straight years of terrible market returns before throwing in the towel. Fund managers say it's both stressful and frustrating. It makes it difficult, if not impossible, to add the best investments to their funds. And it hits them in the pocketbook: They get paid based on a percentage of the assets they manage, and those assets are dwindling as investors pull money out of stock funds.

But mutual fund managers aren't the only ones hurt by panicky shareholders. Indeed, Wall Street experts worry the bigger losers may be the investors themselves. The redemptions are taking money away at precisely the moment when seasoned managers want to scoop up bargains in their favorite companies — after all, the time to buy good long-term companies is when their stock prices are lower, not higher. Meanwhile, a flood of withdrawals makes the funds less efficient and can generate extra taxes. In the worst-case scenario, fund managers have to dump stocks at low prices just to meet shareholder demands for redemptions. Roger Edelen, a finance professor at the University of California, Davis, says that kind of forced trading — whether it's selling or buying — is costly, lowering annual returns by 1.2 percentage points a year on average. Gregory Kadlec, a finance professor at Virginia Tech, puts it another way: It's "a dead weight on performance."

Of course, investors have reasons to put fund managers on a short leash these days. When tech stocks crashed early in this decade, many Americans were left with steep financial losses — and even deeper psychological scars. For those who stuck it out, it took years for their portfolios to recover. Now when things go bad, "people vote with their feet," says Bruce Harrington, managing director of the financial-consulting firm Cogent Research. What's more, impatient investors have a lot more options beyond mutual funds. With improved technology they can simply trade stocks on their own or try other investment tools.

For Nygren, whose fund was off 8 percent in the first quarter of this year, following a decline in 2007, the steady withdrawals mean he can't buy more of his favorite stocks, like credit card giant Capital One Financial. For others, like Cohen & Steers portfolio manager Rick Helm, it has meant selling a stock he likes (Monsanto) to raise cash to buy a stock he really likes (Aflac). Some are so upset by it all that they don't want to talk about it. Legg Mason, which for years enjoyed a reputation as one of the best stock pickers and fastest growers in the mutual fund universe, saw more than $3 billion withdrawn from its funds in just the first two months of this year, including more than $800 million from Legg Mason Value Trust. That fund, run by superstar manager Bill Miller, has been tripped up lately — down nearly 20 percent in the first quarter — by big losses in financial stocks like Bear Stearns.