Stocks vs. exposure

NEW YORK – With stocks shaky, investors have pulled billions of dollars out of mutual funds during the last two months. At the same time, equity funds’ exposure to stocks is much higher than it was a year ago. That increased market exposure could look smart if the market rebounds, but very foolish if it falters.

Exposure can be defined as vulnerability to the market’s fluctuations. A fund that’s completely invested in Standard & Poor’s 500 stocks would have a market exposure of 100 percent, explained Robin L. Carpenter, who runs CarpenterAnalytix.com, where he measures exposure with a statistical analysis of mutual fund activity.

But buying investment vehicles like derivatives can ratchet a fund’s exposure higher or lower, bringing it either below or above 100 percent. Borrowing money to buy stocks can also increase a fund’s exposure past 100 percent, as can shorting stocks. A fund could change its exposure by buying futures contracts that commit it to either buying or selling securities at a set price.

Exposure is increasing across many styles of funds, including small-cap growth and small-cap value, Carpenter said. The increased exposure can happen a number of ways. For instance, a reduction in hedged positions could result in greater exposure. So could a decline in cash or an increase in buying equities.

The increased exposure “is not, in itself, an earthshaking finding,” Carpenter said. But, he added, “It sets up a vulnerability.”

If the market declines, “the buying that seemed sensible and wise turns out to be not so sensible and not so wise,” he said.

The rollercoaster ride that began with the Federal Reserve’s May 10 rate hike has shaken mutual fund investors; net outflows over the four weeks ending June 23 averaged $2.6 billion a week for open-end domestic equity mutual funds, which don’t include Exchange Traded Funds, according to the Bank of America.

Some fund classes have been hit particularly hard, according to Bank of America: Investors pulled $4.05 billion from growth funds for the five business days that ended June 14 and another $1.3 billion the next week. Investors pulled $861 million out of small-cap funds for the week ended June 14 and another $294 million the next week.

Investors have also been fleeing certain sector funds, pulling $205 million from gold funds in one week and $242 million from technology funds.

And some exchange traded funds have seen especially dramatic outflows. In the five days that ended June 21, investors cashed out $5 billion from the $54.2 billion Spyder Trust Series One fund, according to AMG Data Services.

Large actively managed funds keep from 2 percent to 6 percent of their net asset value in cash, said Robert L. Adler, president of AMG Data Services. When the market turns lower, those managers can use the cash to handle redemptions or use more cash to take advantage of buying opportunities in a falling market.