Hot Mutual Fund Sales Are Starting to Cool

THE torrid pace of mutual fund sales during 1994 has begun to slow, reflecting investor concerns about the direction of the United States economy and higher interest rates. On Friday, treasury prices jumped sharply after the government reported that the economy grew at a fast 3.4 percent rate in the third quarter. But many analysts say it is too early to expect a sustained rally, especially in the bond market.

The question now is whether the slower pace in mutual fund sales will continue, putting downward pressure on stock prices, and whether slower sales will lead to total net redemptions in mutual funds, where more assets are withdrawn from funds than added.

The fixed-income side of the mutual fund ledger - bond funds - has been experiencing net redemptions since March. Could that pattern extend to equity funds as well?

The most recent sales data suggests there has been a shift in investor sentiment in the US. Total sales of mutual funds, including bond and equity funds, fell to $35 billion in September from $37 billion in August, according to the Investment Company Institute (ICI), a Washington trade group. Looking back at last year's sales, the drop is even more pronounced. Total sales were $43 billion in September 1993.

Withdrawals from bond funds are increasing significantly. In September, the outflow reached $4.8 billion, the highest level since March. In August, $2.8 billion was withdrawn. Meanwhile, sales for equity (stock) funds were up $8.1 billion in September. But the pace is down sharply from earlier this year. In August, sales of stock funds were $11 billion.

While few investment firms and mutual fund companies are willing to openly discuss the possibility of net redemptions in equity funds, there is anecdotal evidence that some of these companies are modestly increasing cash positions.

The increase in cash is indicative of their need to stand ready to meet higher levels of redemptions, and to have cash on hand to take advantage of buying opportunities later in the year, in case the market shifts.

``We've been recommending an asset allocation of about 10 percent cash, 50 percent equities, and 40 percent in bonds and other investments,'' says Andrew Williams, vice president of Glenmede Trust Company, an investment management firm in Philadelphia. ``We've been on the cautious side,'' adds Mr. Williams, who notes that typically, an investment house will allocate as much as 60 percent of total assets to equities.

``Our feeling around here is that there's no need for investors to be overly aggressive right now,'' in buying stocks, says Dennis Jarrett, a Kidder, Peabody & Co. vice president. Kidder's current portfolio strategy, he says, is to remain ``defensive'' for the next few months.

In recent years, US investors have poured billions of dollars into mutual funds. But with interest rates rising, nonstock investments such as bank certificates of deposit and money market accounts are becoming popular again.

While the pace of new money into equities is expected to continue to slow, most market watchers here say they do not anticipate a rush toward redemptions in stock funds.

``Typically, net redemptions in equity funds do not occur until after a market downturn,'' says James Stack, editor of New York-based InvesTech, a market letter. ``That pattern occurred in late 1987, following the October market crash.''

Still, it is of some concern, Mr. Stack says, ``that this economic stage has reached the point where strong economic news is now perceived as bad news by investors.'' Stack says the economy could be more vigorous than anticipated during the fourth quarter, which may lead to additional belt-tightening by the Fed, when its Open Market Committee meets on Nov. 15. That, he says, could roil bond and stock markets.

The bond market is the key to the next few months, Williams says. If the bond market worsens, then equities could be negatively affected, he says.