Mutual fund investors are finally beginning to warm up to stocks and cool to bonds. But that end-of-the-year shift wasn't enough to overshadow the bigger story of 2010: Risk remained out of fashion.
U.S. investors withdrew $42 billion more from domestic stock funds and exchange-traded funds than they put in during 2010, according to preliminary data on Tuesday from fund tracker EPFR Global.
Investors continued to embrace bonds. They added a net $174 billion into U.S. bond funds in 2010. That's four times as much as they withdrew from stock funds.
The surge of cash into the relative safe haven of bonds fell short of the record amount that flowed in during 2009. Fears about stocks peaked that year after the market's free-fall in late 2008. That led investors to pull $73 billion from stock funds and add a net $213 billion to bond funds.
Those preferences largely held up until the final weeks of 2010, reflecting a disconnect between the stock market's gains and investor behavior. The Standard & Poor's 500 rose 15 percent for the year including dividends. Yet many missed out, because it wasn't until mid-December that investors started to put more cash into U.S. stock funds than they were withdrawing.
The shift in bond flows from positive to negative began about a month earlier. That's when fears about rising interest rates and the financial health of state and local governments began to cut into bond prices, especially for municipal bonds. Since mid-November, investors have pulled $11 billion out of muni bond funds.
Much of that money is going into U.S. stock funds.
"They are frequently the first port of call for nervous investors moving out of fixed income," said Cameron Brandt, an analyst with EPFR Global, based in Cambridge, Mass.
The shifts in the final weeks of 2010, he said, suggest investors are increasingly willing to take more risk for the possibility of a greater payoff.
Yet the shift toward U.S. stock funds is less than a month old, and could prove fleeting. It's too early to say whether the money recently pulled out of bonds will be reinvested mostly in U.S. stock funds, or funds buying foreign stocks.
Those funds were popular last year. For example, U.S. investors added a net $44 billion into funds that buy stocks of companies in emerging markets like China and Brazil.
Brandt said the end-of-the-year flows have been even stronger for funds buying stocks in what are called frontier markets. They offer the prospect of higher returns than emerging markets, but with greater risks. Think of countries like Bangladesh and Latvia.
Yet there was plenty of money to be made in U.S. stocks last year. The top-performers among Morningstar's 21 stock fund categories last year were funds specializing in industrial stocks. Those funds surged an average 30 percent. Funds specializing in consumer discretionary stocks were the second-biggest gainers at 27 percent. The smallest gainers were health funds, up an average 8.4 percent, and utilities funds, up 8.6 percent.
Multisector bond funds, meanwhile, finished the year up an average 10.8 percent, despite the late-year decline in prices for many types of bonds.
EPFR Global's preliminary fund flow data cover U.S.-based mutual funds and ETFs funds through Dec. 31. Money that foreign-based funds and ETFs invest in U.S. stocks and bonds is excluded.
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