Has the Mutual Fund bubble burst?

The Advocate, Wednesday April 12, 1995

I suppose it may seem strange that I would be writing this article, since I advertise myself as a Mutual fund Specialist! But this is the very reason I felt it was necessary to write it. In my previous article of May 4, 1994. I mentioned the fact there was an explosion of the number of mutual funds available in the last ten years.

When I started in the business in 1983 there were less than 200. In 1993 there were over 100 new mutual funds added for a total of 833. On reviewing my latest source disk, there were 1088 listed in 1994. There were 255 new mutual funds added. I find that rather amazing. Imagine, more mutual funds were added last year alone than existed in total up to 1983.

What is that telling me? I seriously have to ask myself the question, who is buying these new funds? Or, should I rather ask, who is selling them? As I stated in my previous article, "I fear a lot of very inexperienced people who I like to call GIC refugees," were lured into mutual funds because of the low interest environment seeking higher returns. The previous year's numbers attracted them. If you just get into mutual funds because they appear to offer a better return then GICs in a particular year, you're in them for the wrong reasons. You probably never sat down with someone experienced enough to properly explain the risks about the investments you bought.

That is exactly what happened last year after the severe downturn, especially in the bond market. Many people who purchased bond funds over-the-counter at a bank or trust company got scared out and lost money. In many cases, they probably would have waited until the bond market recovered and then got out if they had someone who could properly explain the reasons why.

Remember, if you want to make money, you buy low and sell high. After a good year like 1993, there was a lot of good news around. People felt they could repeat last year's performance. They bought high and sold low. This is definitely not the way to make money. People who think in the realm of GICs are victims of that kind of thinking. If they enter the mutual fund arena again (which is doubtful), they have to change their way of thinking. They have to make a paradigm shift.

The time to buy is when prices are low. This usually occurs when there is a lot of pessimism around driving down the prices. It can be very expensive to wait for good news. That is the time when prices are high. This is not the time to buy.

If you can see the wisdom in that, you may still have some difficulty dealing with it emotionally. To be a contrarian is very difficult. Albeit, they are the ones who make money. You may need help to overcome your fears. If you overcome that hurdle, the next question is, out of 1088 mutual funds available, which ones do you choose? Remember, all mutual funds are not created equal. Because of the recent ballooning of the number of mutual funds in the recent years, what happens when the bubble bursts?

This summer I expect more mutual funds will crop up ... like weeds in an empty parking lot. The inevitable will likely happen. It's a case of simple economics. As interest rates rise (they already have), the buying trend will reverse, and people will start investing less money in mutual funds. As that happens, a market sell-off could occur. Why? There are a lot of first-time investors who think a mutual fund is like some kind of bank account. They can't stand to see the value of their savings diminish.

If we start to see a run on mutual fund redemptions, it will be a lot like a run on the banks. If too many people show up demanding their money at once, the fund has to sell stocks, even at a loss to meet the redemptions. The selling cycle will feed upon itself, prices will begin to fall as soon as people stop buying. Lower prices will frighten many investors, who will start to sell.

Fund managers will dump stocks and bonds to pay investors clamoring for cash. Share prices will start heading south as a result. More investors will panic and sell their shares. Prices will fall farther and farther, until the mutual fund bubble bursts!

Who will survive this kind of scenario? Well, those who bought no-load, no-advice, over-the-counter funds will probably be the first to panic. A lot of the newer funds with under-experienced management teams may have to close shop. We have seen this happen before. A lot of amalgamation has taken place in business. A larger, more experienced management company (usually one with a sales force of independent brokers and financial planners who tend to hold their clients' hand through the down times) will roll the fund over and merge it into one of their established funds. There will be winners and there will be losers.

Only a fewer number of funds will survive this kind of environment. Will you be in one of the winners or one of the losers?

Please, for your own economic future, before you invest in a mutual fund, get experienced, professional advice.

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Created: Thu May 16 10:30:50 1996
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