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Volatility Sparks Biggest Fund Exodus Since 2002

Monday, 15 Aug 2011 | 2:40 PM ET

Last week’s unprecedented market volatility caused investors to pull more money out of mutual funds than they did in the aftermath of the 2008 collapse of Lehman Brothers as confusing gyrations trumped the outright fear seen during the financial crisis.

Domestic outflows, excluding ETFs, hit $9.4 billion last week, surpassing the $9.2 billion outflow during a week in October 2008 and the most since 2002, according to a Jefferies report citing Lipper FMI data. Including International funds, net outflows were $11.4 billion. Exchange-traded equity funds had more than $3 billion in redemptions.

“Growing market volatility continues to push investors away from risk,” said Daniel Fannon, a Jefferies analyst covering brokers, asset managers and exchanges, in a note Friday. “Given the ongoing market volatility into this week, we would expect equity outflows to continue in the near term.”

Last week, the Dow Jones Industrial Average moved by more than 400 points for four days in a row, the first streak of volatility of this magnitude ever. Ironically, the average ended the week just 1.5 percent lower as two of those days were gains greater than 400 points.

“There have been a lot of analysts arguing recently that the current period has been even more difficult than the financial crisis, because at least back then ‘we knew what the issues were,’” wrote Paul Hickey of Bespoke Investment Group in a report on the market volatility.

The confusion and volatility last week was driven by the downgrade of U.S. Sovereign debt by Standard & Poor’s following a fierce Congressional fight over the debt ceiling. Creeping uncertainty about bailout plans for Greece and potentially other European countries brought the turmoil to a second continent.

Instead of following the bouncing ball, retail investors took the ball and went home. Money market funds had net inflows of $47.5 billion in assets for the week ending August 10th, according to Lipper.

The quick head for the exits by the retail investor may mark a permanent change in behavior following the biggest financial crisis since The Great Depression and the so-called Flash Crash on May 6, 2010, where the Dow lost nearly 1,000 points in a matter of minutes for virtually no reason.

“The fall of 2008 will leave scars that last a long time,” said Jim Iuorio of TJM Institutional Services. “Prior to the crash of 2008, market participants were considerably bolder. Now, unfortunately, we will probably see investors jump ship when things get too tense because of the bad memories that linger.”

While retail investors dropped out of the market, day traders and high-frequency hedge funds stepped up their activity. Both the CME and the IntercontinentalExchange had record volume.

“The volatility has been a positive for exchanges,” said Jefferies’ Fannon.

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