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Hints of Risk-Aversion in May Fund Flows

Municipal-bond fund flows stabilize, while outflows return to U.S.-stock funds.

Kevin McDevitt, Editorial Director, 06/21/2011

Estimated long-term May fund flows were a healthy $22.6 billion, but this still marked the fourth-consecutive decline from January's $30 billion high-water mark. U.S.-stock funds suffered their first significant outflows of the year, $4.5 billion, as a slow-moving correction ate into gains. International-stock funds, on the other hand, took in about $1.5 billion. But here, too, the pace of inflows has slowed, and once again diversified emerging-markets equity funds accounted for nearly all the deposits. The renaissance continued for taxable-bond funds, which enjoyed $20.8 billion in new flows. This was the asset class' fifth-consecutive month of increasing inflows. The bleeding has even stopped for municipal-bond funds, which had flat flows after six consecutive months of outflows. On the other hand, after a steep drop in silver and other commodity prices, commodities funds fell more than 5% on average and shed more than $500 million in cash. This marked that group's largest-ever outflows and first net redemptions since December 2008.

Money Market Assets Are Stabilizing
Money market funds shed another $2.5 billion in May, which continues a trend of outflows going back to early 2009. However, the pace of such outflows has slowed substantially over the past year. True, the group still lost nearly $100 billion during that time. But that's nothing compared with the nearly $850 billion that evacuated these funds in the 12 months prior (June 2009-May 2010). Plus, this $100 billion in outflows represents just 3.7% of beginning June 2010 assets. At about $2.6 trillion currently, overall money market assets are about where they were three years ago, several months before the Fed began cutting rates aggressively.

After enduring nearly 2.5 years of near-zero yields, the assets still remaining in money market funds may be less likely to leave en masse anytime soon. Investors in these funds may be more concerned with capital preservation than attractive yields. This also suggests that those categories that benefited the most from the exodus out of money market funds, especially taxable-bond funds in 2009 and 2010, likely won't see a similar windfall in the future. Over the past 12 months, taxable-bond funds have taken in nearly $195 billion. But that pales to the 12 months prior, when these funds welcomed nearly $310 billion and money market funds lost $850 billion.

Interestingly, most of the $100 billion or so in outflows over the past 12 months occurred in one month--this past January when the group lost about $79 billion. That month also witnessed the strongest inflows into U.S.- and international-stock funds in more than three years. The two asset classes combined claimed about $24 billion in new money. Given the declining flows into stock funds since then, however, that one-month largesse is looking more and more like a one-time event.

Stock Funds: It's Not January Anymore
With outflows in May and continued equity market volatility, it's easy to wonder whether U.S.-stock funds will return to the pattern of steady outflows seen in 2010. Granted, outflows are not yet close to the 2008-10 period when monthly net redemptions routinely eclipsed $10 billion. But the trend has generally been negative since the group rebounded with $16.5 billion in inflows this past January. In May, the large-value and large-growth categories were again the least popular with about $4.1 billion in combined outflows.

The story for international-stock funds continues to be dominated by the diversified emerging-markets category. As mentioned above, that category accounted for all of the asset class' May inflows. And this trend is hardly new. Over the past year, diversified emerging-markets inflows have accounted for nearly 75% of the $42 billion in total international-stock flows. The category's asset base has now more than doubled during the past two years to $216 billion. This represents about 15% of all international-stock assets.

The past year has shown, though, that superior economic growth does not always lead to superior equity returns. While emerging GDP growth is smoking that of the moribund developed economies, developed equity markets have actually fared better. Through the end of May, Europe-stock funds have gained 35.6% on average versus 28.6% for diversified emerging-markets funds. However, during that same period diversified emerging-markets funds collected about $30.5 billion in new cash while Europe-stock funds lost about $8.2 billion.

Municipal-Bond Funds: Maybe the World Isn't Ending
Investors seem to be getting more comfortable with municipal-bond funds. As mentioned above, flows in May were flat after six months of outflows, and tax-exempt money market funds actually had about $1.6 billion in inflows. The trend has been improving, in fact, ever since Meredith Whitney's apocalyptic forecast last December, in which she predicted mass municipal defaults. Outflows peaked at $13.2 billion that month and have been gradually lessening ever since.

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