Business - Of Mutual Interest Investment pros open up about their fears Annual conference was held during nervous time in the stock market

By Mark Jewell

AP Personal Finance Writer

BOSTON (AP) -- Big names in the investment world are plenty worried these days.

Their biggest fears:

--Normally safe bonds could be set to fall;

--More frequent stock trading heightens the risk of another market "flash crash" like the one on May 6;

--Reforms to prevent another meltdown are failing to tackle key issues, such as mounting government debt, a long-term inflation threat and risky banking practices.

Investment pros revealed their anxieties before 1,600 colleagues in Boston last week for the annual conference of the Chartered Financial Analysts Institute.

It came at a nervous time in the stock market. Choppiness has returned, punctuated by a brief plunge of nearly 1,000 points in the Dow Jones industrials two weeks ago.

It's given pause to investors who were regaining confidence. Money flowed into mutual funds for 60 consecutive weeks, dating to the market bottom of March 2009. But the string snapped when investors pulled out $14 billion in the week ended May 12.

Investors took their money out of stock funds as well as bond funds, which had provided refuge from stock market volatility. Since the start of 2009, 25 times more money has flowed into bond funds -- some $500 billion -- than into stock funds.

That fixed-income fixation touches on a key fear that emerged at this week's CFA meeting. Some highlights:

--Christopher Davis, co-manager, Davis New York Venture Fund (NYVTX).

At $34 billion, Davis' large-cap fund is popular because it's beaten the Standard & Poor's 500 index over every rolling 10-year period since its inception in 1969.

Davis recognizes investors are nervous about stocks. The market is officially in a correction, a drop of 10 percent or more from a recent high. This is the first correction since stock indexes hit 12-year lows in March last year. Still, Davis is especially worried for those who have piled into bonds lately.

"I think the only real bubble in the world now is bonds," Davis said. "Bonds may be great for another year or two, and they may beat inflation. But when you look over a 10-year period, people are going to get killed."

If Davis is right, investors looking to sell bonds before they mature could find they won't get a decent price. Depressed prices also could turn bond funds' typically positive returns into losses, as happened in late 2008.

Davis argues bonds have enjoyed a 30-year run. This was notably capped by a decade when the 6.3 percent average annual return for taxable bonds looked huge against the average loss of nearly 1 percent for S&P 500 stocks.

He also worries that government borrowing has created risks not reflected in the low yields investors are getting for U.S. Treasurys. For example, the yield on the benchmark 10-year Treasury note has been just above 3 percent, as investors have sought safety.

"The idea of financing (the federal government) at 3 percent seems crazy to me," Davis says.

"More money has gone into bonds in the last 12 months than has ever gone into any single asset class in a 12-month period," he says. "That is a terrifying idea."

Davis is puzzled that investors seem reluctant to latch onto stocks of global brands he likes, such as Nestle, Coca-Cola and Procter & Gamble. They offer attractive earnings yields of 7 percent to 8 percent, with little risk, he says. The earnings yield is the ratio of a company's earnings per share divided by its stock price. This metric helps investors assess the potential growth to expect from a stock investment.

--John Bogle, the 81-year-old retired founder of Vanguard, the mutual fund company that pioneered low-cost index investing:

Bogle, a frequent industry critic, worries that more episodes like the recent flash crash lie ahead.

He says it's a symptom of a "rent-a-stock" mentality that forces long-term individual investors to join the bumpy ride dictated by bigger players. When Bogle started in the business 60 years ago, individuals owned 92 percent of stocks, with institutions such as pension funds and endowments holding the rest. Now, the situation is reversed, with institutions owning 70 percent.

They move huge sums in and out of stocks, often within seconds, using computer-driven trading. For example, more than half of the $76 billion worth of shares in an exchange-traded fund mirroring the S&P 500 index changed hands on Wednesday alone.

"We have gone from the wisdom of long-term investing to the folly of short-term speculation," Bogle says. "It used to be you invested in businesses. Now, it's investing in stocks."

Bogle also says the financial reform package before Congress doesn't go far enough. For example, he faults Washington for failing to reinstate the 1930s Glass-Steagall Act that separated commercial banking from investment banking. Most of the law's restrictions were repealed in 1999, which many critics cite as a key factor in the 2008 financial crisis.

--Seth Klarman, a money manager with the Boston-based firm Baupost Group:

Klarman isn't well-known to mutual fund investors because he's from the more rarified hedge fund world. He's a value investor famous for outsized returns averaging 20 percent a year since he founded Baupost in 1982.

Klarman said he's keeping about 30 percent of his firm's $22 billion in cash now because he doesn't see many good investment deals. His chief worries? The government's inability to control spending, the related risk of long-term inflation, and the economy's reliance on stimulus that's now being withdrawn.

He fears this decade will finish like the last, and stocks will lose money or post minimal returns.

Politicians haven't tackled a single hard problem, he says, and there's no evidence they will: "Every can is being kicked farther down the road.''

Published: Mon, May 24, 2010