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Investors continuing retreat from stock mutual funds

Investors sought refuge from the market’s volatility in August, withdrawing money from stock mutual funds and bond funds alike. The retreat from stock funds was unusually heavy for the third consecutive month, marking a renewed aversion to risk.

A net $21.4 billion was withdrawn from U.S. stock mutual funds in August, and $10.8 billion from bond funds, industry consultant Strategic Insight said Wednesday.

Last month’s exit from stock funds followed net withdrawals of more than $23 billion in July and $17 billion in June. The three-month trend marks an about-face from the start of the year, when investors consistently deposited more than they withdrew. Now, the year-to-date stock fund flow is negative, with $21.2 billion in net withdrawals.

Investors have turned away from stocks as the Standard & Poor’s 500 index has declined four months in a row, capped by a 5.4 percent drop in August. The month was marked by extreme declines and rebounds, and a U.S. credit rating downgrade by S&P following a last-minute congressional deal to raise the nation’s debt ceiling.

Worries about the U.S. economic recovery and Europe’s debt crisis have added to investors’ fears, said Avi Nachmany, research director with New York-based Strategic Insight. The company said fund investors were “clearly shaken by a dramatic month.”

Other details of how investors moved their money in August:

-Foreign stock funds: Investors withdrew a net $1.4 billion from funds that buy foreign stocks. Flows into this category have been negative for two months in a row, but remain positive year-to-date, with nearly $44 billion in net deposits.

-Bond funds: Investors typically are attracted to bonds when stock prices tumble. That was the case in July, when bond funds attracted $8 billion in net deposits.

But last month, investors in taxable bond funds — a category that includes corporate bonds — withdrew a net $9.7 billion. Strategic Insight noted big withdrawals out of floating-rate and high-yield bond funds. Both categories hold bonds that typically earn high rates of return, with greater risk of volatility. About $1.1 billion was withdrawn from municipal bond funds, which buy the debt of state and local governments.

However, Nachmany said demand for bond funds should rebound, as they began to attract new money toward the end of August. He also noted that bonds will continue to look attractive given expectations of continued stock volatility, and the Federal Reserve’s statement last month that it plans to keep interest rates very low until at least mid-2013, assuming the economy remains weak. Bond yields look attractive compared with the near-zero returns that bank accounts and money-market mutual funds now offer.

(bullet) Money-market funds: A net $69 billion was deposited into these funds, designed to be safe harbors where investors can temporarily park cash and quickly access it when needed. That proved a strong draw in August, in contrast with July. In that month, investors withdrew a net $113 billion, due to fears that Congress might fail to reach an agreement to lift the government’s debt ceiling. Investors were scared off because nearly half of the $2.6 trillion that money funds hold is invested in Treasury bonds.

(bullet) Exchange-traded funds: Investors deposited a net $1 billion into ETFs, which bundle together investments in a particular market index. Unlike mutual funds, they can be traded during daily sessions just like stocks. Through the first eight months of the year, net deposits into ETFs total $89 billion, a pace that could lead to a fifth straight year with more than $100 billion of inflows into ETFs, Strategic Insight said.