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Mother of Flowmageddon

Outflows across a complex can be damaging to fund parent companies.

Russel Kinnel, 04/21/2016

A version of this article was published in the March 2016 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor here.

In my "Flowmageddon" article that ran a couple of weeks ago, I mentioned that outflows can be damaging to the parent company--not just an individual fund. This week, I'll delve into that ground.

The impact of redemptions on a fund company is less obvious than at an individual fund, but still quite real. It's a challenge that is facing more fund companies than usual. I pulled the 50 largest calendar years of outflows in percentage terms to hit any fund company in the past 20 years. Remarkably, 10 of the 50 came in 2015. The next biggest year was the bear-market year of 2008, when five firms had big redemptions. (I limited the search to firms that had at least $5 billion in assets to begin the year.) The 10 biggest percentage drops in open-end funds from 2015 had outflows that ranged between 17.8% and 26.0% in a single calendar year. Fund companies can certainly rebound from such an event, and they have, but it does present new challenges. Asset management is a high-profit, low-debt business, and that means fund companies generally have some slack before flows hurt them.

Source: Morningstar.

Marsico Capital is one firm that has suffered a slow burn as redemptions and poor performance have gradually eaten away at its standing and led to departures in investment personnel. Marsico had an unusually high level of debt because of a 2007 deal in which it bought control back from Bank of America BAC.

More broadly, outflows can spur staff cuts, harm a firm's reputation, hurt performance, and make it tougher for a firm to recruit top talent. Let's take a look at those that are most worrisome among the 10 suffering outflows. 

Third Avenue's 26% outflow tops any firm over the past 20 years. Having a fund in the headlines because of a mismatch of flows and holdings liquidity will do that to you. The firm faces an investigation and changes at the top, and investors are fleeing the rest of the firm's funds besides the one that imploded. The reasoning is fear that problems at the firm will lead to big changes or possibly key departures at the other funds. Third Avenue is owned by Affiliated Managers Group AMG, which is on solid footing itself, though AMG generally takes a hands-off approach with its investment boutiques. If you own a Third Avenue fund, you should watch developments closely. It's tough to come back from a severely damaged brand. Even before the scandal, manager departures and poor performance had led us to downgrade a number of the firm's funds.

Wasatch shed about 19% of assets, and that's a concern given its emphasis on small-cap stocks in most funds. The good news is the firm endured a sizable drop in assets under management a decade ago but was able to keep its investment team intact and rebounded nicely. Still, I worry when I see this in small-cap land. 

Russel Kinnel is Morningstar's director of mutual fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping investors pick great mutual funds, build winning portfolios, and monitor their funds for greater gains. (Click here for a free issue). Mr. Kinnel would like to hear from readers, but no financial-planning questions, please. Follow Russel on Twitter: @russkinnel.

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