Recent data showing that net flows into the mutual fund industry were off 51 percent in the first quarter of this year are deceptive and should not be regarded as an indicator of the industry's health, according to Strategic Insight, a mutual fund research and consulting firm in New York.

Financial Research Corporation of Boston recently released data that showed long-term net flows - new sales less redemptions - into stock and bond funds in the first quarter were down 51 percent to $42.1 billion from $86.7 billion a year earlier (MFMN, 5/10/99).

But, Strategic Insight said in a recent client newsletter that new sales of stock and bond funds surged 19 percent to $275 billion in the first quarter of the year from $231 billion a year earlier. Strategic Insight based its report on Investment Company Institute data.

Strategic Insight discounts the effect of redemptions, arguing they are unrelated to new sales. Redemptions are usually made to pay for basic living expenses, like college tuitions or mortgage down payments, the firm claimed in its newsletter. "Only a small portion of redemptions reflects reactions to market trends at any one time," the newsletter said.

"I think it's terribly misleading to measure marketing opportunities by net cash flow," said Avi Nachmany, a Strategic Insight analyst. "The potential for marketing opportunities should really be measured by new sales because new sales represent the collective new demand for mutual funds."

Up until December, equity fund redemptions had maintained a steady pace of 1.5 percent. But, since December, the level has risen to two percent, causing "a sharp decline in equity fund net cash inflows," he said.

FRC's first quarter data was also alarming because it showed that 96 percent of net inflows went into the top 25 best-selling funds. Those findings are telling, Nachmany said.

"Investors have become more enamored than ever with a few investing styles, and that contributed to a slowdown in net cash flows and a higher concentration in a few fund companies," he said. But Nachmany thinks this is about to change.

Investment style rotation away from large cap growth and large cap blend funds - particularly technology, high-yield corporate bond and Japan funds - is bound to happen sometime soon, according to the newsletter.

"Because the performance gap between investment styles recently became quite wide, the probability of style rotation is very high," according to Strategic Insight. "When smaller-cap, value funds and international stock investments shine again, a large number of such actively run funds . . . will find favor among investors."

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