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Whatever Happened to U.S. Stock Funds?

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For the nearly 20 years since the inception of the Jensen Quality Growth Fund (JENSX), Robert Zagunis has managed this U.S. equity fund by being choosy about selecting companies that have generated returns on equity of at least 15% for each of the previous 10 years.

Robert Zagunis, Jensen Quality Growth Fund (JENSX)As a result, Zagunis’ (left) large-growth, long-only domestic equity fund has earned Morningstar’s Gold analyst rating and a solid 9.56% return year to date as of Aug. 31 (though not as high as its category peers’ return of 13.34% and the S&P 500’s return of 13.51%).

“Although the fund’s character has changed a bit lately, it’s still a sturdy, very attractive long-term holding,” wrote Morningstar analyst Greg Carlson about JENSX in a May 30 comment. “In 2012, the fund has held up well as the market has retreated in the second quarter. Its long-term record is still impressive: It’s outpaced more than 80% of its peers over the trailing 15 years and suffered much less volatility than average.”

Yet money is leaving JENSX: $224 million has poured out of the fund, which had a total of $3.9 billion in total assets under management as of Aug. 31, said Michelle Swartzentruber, Morningstar research analyst, in a phone interview on Tuesday.

“That’s really what’s been happening with good equity funds. The money has been leaving,” Swartzentruber said. “Over all, even equity funds that are performing well are seeing outflows.”

And there, in a nutshell, is the problem: many sectors of the U.S. stock market have seen handsome returns since the crash of 2008, but wary U.S. investors don’t want to trust their money to long-only, actively managed domestic stock funds. Instead, they’re putting their money in bond funds—even though yields are at historic lows.

Trend-Chasing Yields Frustration

No one is more frustrated about this state of affairs than the stock fund managers.

“Investments tend to evolve into what’s newer and shinier, but we do one thing well, quality growth investments, rather than trying to chase the next big trend,” said David Mertens, a principal at Jensen Investment Management of Lake Oswego, Ore., in an interview in mid-September.

The Investment Company Institute (ICI) in its most recent report on trends in mutual fund investing showed that stock funds that invest primarily in the United States had an outflow of $9.59 billion in July versus an outflow of $8.96 billion in June.  Bond funds saw an inflow of $24.62 billion in July, compared with an inflow of $16.29 billion in June, ICI said.

Just as significantly, more people are investing in alternatives. According to a Natixis Global Asset Management survey released on Tuesday, most institutional investors, or 76%, said they now consider the use of alternative investments including commodities, real estate and private equity.

“Three in four (73%) say it is necessary to invest in alternatives in order to outperform the broad market,” Natixis reported. “One in three (29%) report that increasing their allocation to alternative/noncorrelated assets is one of their organization’s three highest investment priorities in the next 12 months.”

Alternatives Complicate Fund Outflow Story

To be sure, the chase after alternatives has complicated advisors’ lives—and much education is required. Mertens predicted that the talk at Schwab Impact 2012 this November will be largely about alternatives rather than traditional long-only stock funds.

“It’s a burden for advisors,” Zagunis said. “It’s complicated, and it’s getting more complicated.”

American Beacon Advisors President and CEO Gene Needles, whose company works with a wide range of fund subadvisors, agreed that the exodus of money out of domestic equity funds is troubling.

“There is an erosion of investor confidence in the market due to investors who believe that the game is rigged,” Needles said at an American Beacon media day in New York on Sept. 19.

Pointing to the 2008 financial crisis as well as the 2010 flash crash, Needles said: “As an industry, we want to support the SEC to ensure that the U.S. markets are the best in the world.”

Meanwhile, U.S. stock fund managers muddle along.

Bob Auer of the Auer Growth Fund (AUERX), for example, believes that he has found a sound strategy by buying stock in fast-growing small-cap companies at what Auer calls “ridiculously low” prices, meaning companies that are up 25% in profits, up 20% in sales and with a P/E ratio of 12 or under.  His top holdings include Western Digital Corp., C&J Energy Services and Titan International.

Yet Auer’s nearly four-year-old fund has struggled to find its footing, with a 145.4% turnover and choppy returns since its December 2007 launch.

“For the last four years, [the markets have] left us like an orphan with our nose pressed against the window,” Auer said.


Read Fiscal Cliff, Poor Returns Push Wealthy Into Alternatives: Spectrem at AdvisorOne.


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