Shareholder redemptions of stock funds steadily accelerated in 1997 and 1998, a trend which could change the priorities of mutual fund companies.

Stock fund redemption rates as a percentage of new fund sales have risen from 54.4 percent in 1996 to 76.2 percent last year, according to a recent report from Financial Research Corp., a fund research firm in Boston. Shareholders appear to be taking at least a portion of the proceeds of their sales and investing in lower-margin money market funds, perhaps with an eye to ultimately investing directly in stocks or separate accounts, according to FRC.

The trend suggests that fund companies should pay increasing attention to retaining shareholders by offering new services and products, said Charlie Bevis, the FRC senior writer who conducted the analysis on equity fund sales.

Services such as asset allocation models for investors and varied fund products may help keep assets within a fund family, he said.

"I think customer service has been under-appreciated," Bevis said.

In addition, companies should try to identify investors who appear most likely to redeem and develop strategies to try to retain those investors, Bevis said.

Historically, there has been "more emphasis on selling and marketing to get assets in the door," Bevis said. Fund companies "might be able to hold on to more assets by watching the back door."

FRC's examination revealed the following sales and redemption trends: stock, fixed-income and hybrid funds, which combine the strategies, have represented a fairly constant mix of new sales since 1996. Approximately 70 percent of new sales have been in stock funds, 22 percent in fixed income funds and eight percent in funds which invest in both stocks and bonds.

During that same three-year period, however, redemption rates as a percentage of new sales for bond funds have dropped from 91.3 percent to 69.1 percent. Meanwhile, stock fund redemptions rose from 54.4 percent in 1996 to 62.5 percent in 1997. Volatility in the equity markets last year helped push redemptions for stock funds to 76.2 percent. Historical levels of equity fund redemptions range from 55 percent to 60 percent of new sales, according to FRC. New sales last year were about $1 trillion, FRC reported.

It is not entirely clear where the proceeds of stock fund redemptions are going. Money market funds, which had record net sales of $235 billion in 1998, appear to have been a beneficiary, according to FRC.

However, a significant but un-quantifable portion appears headed for investment directly in securities or in separate accounts, Bevis said. He attributed the popularity of those alternatives in part to financial planners searching for new ways to provide solid investment returns for their clients. Last year's equity fund redemption rate also was due in part to volatility in international markets, Bevis said.

The trend in redemption patterns will contribute to a squeeze in the profitability of mutual fund companies, Bevis said. Mutual fund companies normally charge higher management fees for equity funds than for fixed-income or money market funds.

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