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Redemptions Hit an All-Time High in September

Plus, Schroder muni funds liquidate, T. Rowe Price launches bond fund, and more.

Morningstar Analysts, 10/17/2008

Morningstar's fund analysts cover 2,000 mutual funds. Their full analyst reports, including Stewardship Grades, are available in Morningstar Principia Mutual Funds Advanced and Morningstar Advisor Workstation Office Edition.

The recent market upheaval has triggered the largest wave of monthly net redemptions in the history of the mutual fund industry. In September, investors pulled an estimated $47.5 billion out of mutual funds, capping off an erratic month that featured the federal takeover of Freddie Mac FRE and Fannie Mae FNM, the bankruptcy of Lehman Brothers, the government's bailout of American International Group AIG, and plans for a massive government rescue package. Investor concern about the deepening financial crisis and a money market fund "breaking the buck" contributed to the record-setting flight from funds.

Almost no asset class was left unscathed. International stock funds were hit the hardest, with more than $19.9 billion in outflows in September. U.S. stock funds weren't far behind, experiencing roughly $19 billion in net redemptions. Balanced funds, which buy both stocks and bonds, saw a drop of nearly $5.9 billion, and taxable and municipal bonds faced estimated net outflows of $1.6 billion and $1.4 billion, respectively. The alternative asset class--which includes long-short, bear market, currency, and precious-metals funds--was the only class that didn't experience redemptions, instead seeing inflows of $340 million. Many of these funds have historically performed well when the rest of the market is suffering.

September's substantial outflows were far worse than those experienced during any month of the bear market of 2000-2002. July 2002 was the worst month during that stretch and saw net redemptions of $17.4 billion (roughly three times less than September 2008's outflows). Although investors fled from stock funds in droves during that bear market, they moved a lot of money into bond funds, which were thriving at the time. This time around, though, the current credit crisis has roiled nearly every segment of the market, and many investors have simply pulled their money out of mutual funds altogether.

Schroder Funds Bite the Dust
Massive shareholder redemptions have forced Schroder Municipal Bond SMBIX and Schroder Short-Term Municipal Bond STMIX to shut down and liquidate. Illiquidity has plagued the municipal market in the weeks since Lehman Brothers' collapse, making it difficult for these funds to sell securities to meet redemption demands. While recent weeks have severely hampered many muni funds, these two funds actually started running into trouble in the earlier stages of the credit crisis. In particular, the funds owned a sizable stake in floating-rate bonds that were hit hard earlier this year, and redemptions started increasing in April. Between April 1 and Sept. 30, Schroder Municipal Bond lost roughly a fourth of its assets to outflows, according to Morningstar's estimates. Both funds have been among the worst performers in their categories this year: Schroder Municipal Bond was down 12.6% in the year to date through Oct. 14, 2008, and Schroder Short-Term Municipal Bond lost 7.3% in the same period.PAGEBREAK

The funds closed to new shareholders Oct. 14, and the liquidation will occur in stages. Shareholders can expect the first capital distribution on or around Nov. 28 and subsequent distributions after that. Schroder also announced that fund comanager Susan Beck has taken over leadership of the firm's muni team from David Baldt, although Baldt remains with the firm.

Muhlenkamp Mulls Fund Distributions
's MUHLX longtime manager, Ron Muhlenkamp, posed a question to fund shareholders in his quarterly newsletter: Do shareholders prefer a capital gains distribution this year or in the future when tax rates could be higher? In 2007, some investors were miffed about paying taxes on capital gains in a year that the fund lost money. This year, the fund is also down--it's lost 38.1% in the year to date through Oct. 15, 2008--and it's again incurred large capital gains, mainly from energy holdings that it sold earlier this year (which turned out to be a good move; energy stocks have generally dropped since the summer). Muhlenkamp noted that the upcoming presidential election opens the door for a potential increase in the capital gains tax from its current rate of 15% to 20% or more. If that were to happen, he notes, it would make sense to maximize the capital gains distribution this year when rates are still low. However, he encouraged shareholders to call in and voice their preference before he decides whether to declare a distribution.

We always like to see managers putting shareholders' interests first, and Muhlenkamp's call for input is certainly a shareholder-friendly move. The small, one-fund shop with $865 million in assets may also be hoping to deter redemptions by trying to keep investors happy.

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